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Sydney Morning Herald

Wednesday July 16, 2008

Greg Canavan. Greg Canavan is head of Australasian research at Fat Prophets

What's new? We hear so much about the need to create competitive goods-and-services markets. Competitive labour markets are crucial to keeping wages and therefore inflation down. But where's the competition at the executive end of the labour market? The answer is that it's non-existent. Rising executive wages and poor performance attest to it.

Last week, IAG provided investors with a "strategic update" and, among other things, admitted that its decision to expand into Britain has been a failure. So far, $350 million in shareholder wealth has been destroyed and, depending on the success of its exit strategy, there could be more to come.

Judging from last week's presentation, the British failure can be put down only to insufficient or inadequate research in identifying the acquisitions. IAG's failed expansion, though relatively minor in size, joins a long list of Australian companies that have destroyed shareholder value by looking for growth offshore. (That's not even including the billions lost by property trust managers "expanding" into the US in recent years.)

This lack of strategic foresight by the Australian corporate sector is worrying, considering it is largely being financed by the country's huge superannuation savings pool. Let's hope it doesn't evaporate too much.

The outlook With IAG's previous chief executive Michael Hawker shown the door, new boss Michael Wilkins (formerly head of Promina) has reversed course and is focusing on IAG's home markets of Australia and New Zealand. Wilkins will simplify the company's operating structure, "creating end-to-end businesses with autonomy to manage their own brands, customer bases and markets".

IAG has great brand names, including NRMA, RACV, SGIO and CGU. Wilkins's plan is to have them operating autonomously - in much the same way as Promina was managed. Hardly rocket science but nonetheless the plan has been well received by the market. The planned restructure comes at a one-off cost of $60 million, designed to save $130 million a year.

For next year, IAG's insurance margin will be about 6 per cent, which represents bottom-of-the-cycle profitability. Given the weak profit outlook, the final dividend has sensibly been reduced to 9 cents, bringing the full-year payout to 22.5 cents - down from 29 cents last year. Providing some indication the company is looking to rebuild its balance sheet, future dividend payments are expected to be about 60 per cent of earnings.

Price Over the past five years, IAG's share price has done very little. And we expect the stock to continue doing very little for the next six months or so (notwithstanding the emergence of a new bid from QBE). However, the lows reached in early March could prove to be the bottom, with a gradual improvement in profitability and share price.

Worth buying? Despite the depressed share price, IAG is not a standout buy at this stage. Given the considerable destruction of shareholder wealth, the share price falls have been largely deserved. A turnaround from here depends on the ability of the new management team to improve profitability. Wilkins has form on the board, so existing shareholders should continue to hold the stock but prospective buyers can afford to take a wait-and-see approach.

© 2008 Sydney Morning Herald

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