Capital returns have been a big theme on our market and a leading broker reckons this S&P/ASX 200 Index (Index:^AXJO) share could be next inline.
Companies have been handing back excess cash to shareholders over the past year. As I wrote yesterday, capital returns are expected to contribute to the $84 billion plus cashback that investors can look forward to.
The ASX 200 shares with up to $800m in extra cash
Another ASX 200 company that could be looking to deploy the cash it doesn't need to reward shareholders would be the Insurance Australia Group Ltd (ASX: IAG) share price.
Morgan Stanley reckons the insurer could have up to $800 million in cash that is surplus to its business needs.
But this is premised on whether the insurer getting a favourable outcome in a test case relating to business interruption (BI) claims related to the COVID-19 pandemic.
Court case to test ASX insurers
IAG isn't the only insurer facing this challenge. The QBE Insurance Group Ltd (ASX: QBE) share price is also under the same cloud.
Insurers have largely rejected claims put in by small and medium sized businesses that have lost money due to lockdowns.
The claimants are taking insurers to court, and if they win, ASX insurers could be on the hook for a very large bill.
Release of provisions key to IAG's capital return
IAG has put aside $865 million in claims provisions. If they can convince the judge that their insurance does not cover pandemics, most or all of this could be transferred back to profit.
This will leave IAG with a lot of excess cash given that they are already have a cash buffer that is above the requirement set by APRA.
"IAG has chosen to run as high as ~1.2x CET1 in recent years, slightly above its 0.9-1.1x preferred range," said Morgan Stanley.
But even if IAG had to pay out around 50% of its provisions in claims, Morgan Stanley believes that it will still have circa $650 million of excess capital. This is from $425 million in BI claims savings post-tax and $225 million in capital drag release.
How ASX 200 shares return cash to shareholders
However, unlike the Suncorp Group Ltd (ASX: SUN) share price, IAG is unlikely to pay a special dividend to shareholders.
In fact, it is also not likely to do a off-market share buyback like Commonwealth Bank of Australia (ASX: CBA).
"With IAG holding close to nil franking credit balance at FY21, we believe IAG will have limited ability to pay franked special dividends in the next two years. An on-market buyback is the more likely scenario," said Morgan Stanley.
"Our earlier work also showed that there is little evidence of buybacks leading to share price outperformance in financial stocks, based on our historical buyback analysis."
Given this, it's hard to get too excited about the IAG share price. This is probably one reason why the broker is recommending the IAG share price as "equal weight" (equivalent to "hold") with a $4.80 a share price target.
