It isn't easy for companies caught up in the Haynes Royal Commission to find a silver-lining but Insurance Australia Group Ltd (ASX: IAG) may have just gotten lucky!
Its share price jumped an impressive 3.6% to $7.24 when the S&P/ASX 200 (Index:^AXJO) (ASX: XJO) index was flat after Credit Suisse upgraded the stock to a buy on the back of revelations at the Royal Commission.
Ironically, it's the damning revelations from the Royal Commission that had triggered a big derating in the share prices of financial institutions like Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd. (ASX: NAB) and AMP Limited (ASX: AMP).
IAG was also swept up in the probe with its share price slumping 13% in the past three months before Thursday's rally but the pain may have been worth it.
Credit Suisse had been puzzled by the insurer's shrinking underlying insurance margin for its commercial lines despite two years of premium rate increases.
The broker's inability to account for the margin squeeze is a key reason why it had a "neutral" rating on the stock.
"Due to the abundance of commercially-sensitive information that is being provided by the Royal Commission, we can now see that a large reason for this has been the exit of the Swann business," said Credit Suisse.
"While IAG reported an underlying margin decline of 280bp [basis points] in its Australia Business division in FY17 and a further 30bp decline in FY18, excluding the impact of the Swann divestments, we estimate the decline to be 90bp in FY17 and an expansion of 50bp in FY18."
Now that the broker can explain the margin movement, it is more confident that management can meet or even exceed its FY19 margin forecast and has upgraded its recommendation on the stock to "outperform".
If that isn't enough to get investors excited, Credit Suisse estimates that IAG will have a further $600 million to splash on shareholders. This could come in the form of a $300 million special dividend and $300 million share buyback.
"While IAG has been the best performing insurance stock in the past 12 months (+13% TSR above ASX200), the stock has pulled back in the last four months which we don't see as justified," said Credit Suisse.
"The pullback provides an opportunity to buy a high-quality company at an attractive entry point."
The broker has a $7.90 price target on the stock.
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