Is the Insurance Australia Group share price in the buy zone?

The Insurance Australia Group Ltd (ASX: IAG) share price has risen 4.1% to $7.60 following last week’s announcement of its half-year results for the period ended December 31, 2018.

Mixed report

IAG saw gross written premium (GWP) increase by 4.1% to $5,881 million on the back of premium increases and a positive foreign exchange effect from its New Zealand business. However, whilst GWP rose, the company reported a 33.4% fall in insurance profit to $496 million and net profit after tax from continuing operations declined by 47.6% to $293 million.

The bottom-line softness occurred after IAG exceeded its first-half natural perils allowance by $110 million, with the main catalyst being the $162 million contribution from the Sydney hailstorm in December.

As a result of the lower statutory profit, IAG has lowered its interim dividend from 14 cents to 12 cents. However, it should be noted that IAG did pay out a special dividend of 5.5 cents alongside a capital return of 19.5 cents in November.

On a more positive note, the company’s underlying insurance margin rose 320 basis points to 16.2%. Underlying insurance margin is the company’s reported insurance margin adjusted for net natural peril claim costs less related allowance, reserve releases in excess of 1% of net earned premium and any credit spread movements.

Furthermore, and perhaps why the market has reacted positively after the release of the earnings report is that IAG reaffirmed guidance of GWP growth of 2%-4% for FY19 with reported insurance margin guidance of 16%-18%.

Foolish Takeaway

IAG has had a solid 12 months, gaining 6.1% plus dividends and a capital return. It has outperformed other blue-chip stocks such as AMP Limited (ASX: AMP)Australia and New Zealand Banking Group (ASX: ANZ) and Suncorp Group Ltd (ASX: SUN).

At current prices, IAG is trading for around 17 times consensus FY20 earnings with a 4.2% dividend that comes attached with full franking credits. However, investors should note that IAG’s franking credit balance has fallen over the last several years due to the company’s capital management measures and increased dividend payout ratio. Thus, the company has indicated that it may not be in a position to fully frank distributions from the second half of the calendar year 2019 onwards. IAG has stated that investors can expect future franking rates in the range of 70%-100%.

With all of that in mind, at a valuation multiple of around 17 times consensus FY20 earnings, IAG appears fairly valued in my view. I would like to see a lower valuation multiple before opening a position in one of the more conservative investments on the Australian market.

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Motley Fool contributor Tim Katavic has no financial interest in any company mentioned. The Motley Fool Australia owns shares of Insurance Australia Group Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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