WHEN Mike Wilkins jumped into the saddle as white knight of Insurance Australia Group almost three years ago, he gave himself a year to get the insurance company right. His big-bang strategy included a decision to keep part of its disastrous British business.
That decision, which was viewed by many as foolhardy at the time, continues to haunt the company, its profits and its share price.
Wilkins's overhaul of the company and the British operation has not gone well.
The share price has gone backwards and the ratio of profit downgrades to upgrades is 7:1. If the number of downgrades is tallied up since he joined the board in November 2007, the ratio of downgrades to upgrades balloons to 10:1.
Britain and the floods are the main reasons for yesterday's slashing of interim earnings from $329 million to $161 million.
Interestingly, the share price fell only 4 per cent, to $3.63, largely because the market is getting used to these downgrades and so had already factored in a piece of it.
The best explanation for the tardiness of the announcement was the board wanted to combine two downgrades into one.
Like National Australia Bank, the problem with IAG is not the Australian business but the British business. Both companies had the opportunity to get out of Britain a few years ago. Both decided to hedge their bets and keep a part of the British business.
While it is true that Wilkins's predecessor, Michael Hawker, was responsible for the group's expansion into Britain, it is a mess that Wilkins has not tidied up. The latest downgrade was attributed to a greater than expected insurance loss from the British operation of $121 million.
It is a dark reality that will put pressure on IAG to push harder to convince the RACV to sell the remaining 30 per cent of a lucrative joint venture IAG owns with it.
This column in December revealed that IAG was looking at the joint venture, Insurance Manufacturers of Australia. IAG would have been far better off if it had spent $1.6 billion on the IMA business rather than spending that amount on the British business, which has resulted in substantial losses and impairment charges.
A letter is believed to have been written to the board of RACV with a proposal to buy IMA for up to $1.5 billion. The RACV board declined the offer and has not heard back. But now more than ever it makes sense, as pressure mounts on IAG to start getting some runs on the board.
The IMA joint venture is the star in IAG's portfolio. It represents almost a third of its premiums but contributed almost two-thirds of its cash earnings in 2010. If the British business keeps going the way it is, IMA might end up contributing more to the IAG profit.
The IMA joint venture, which was brokered by Nick Whitlam when he was chairman of IAG and the NRMA, houses the RACV and NRMA home and car insurance businesses and is highly profitable.
If Wilkins can pull off the purchase, it will stop investors looking at his performance and the size of his remuneration package, which includes a base salary of $1.85 million, along with incentives that could earn him more than $4.28 million.
Leighton languishing
PROFIT downgrades are never pleasant, particularly for a company that is staring down the barrel of a potential change in parents and therefore the board. For Leighton Holdings, the country's biggest construction and mining services company, the headline profit downgrade is worse than at first glance.
The company released its results yesterday, saying it expected full-year net profit to fall from a previous guidance of $510 million to $480 million, after reporting a 25 per cent drop in first-half profit. But this is comparing apples with oranges.
The $480 million full-year guidance includes the $202 million profit booked from the sale of a 30 per cent stake in its Indian business, and the $510 million does not.
This implies full-year guidance is being downgraded from $710 million to $480 million, equivalent to a 32 per cent downgrade.
What makes it worse is Leighton sold the Indian business the day before Christmas at a lower price than the market expected, leaving some to wonder whether it was pushed through to boost the half-year results.
The downgrade was blamed on cost overruns at its Airport Link project in Queensland, its business in the Middle East, Al Habtoor Leighton, wet weather in Queensland and Indonesia, and the high value of the Australian dollar.
It was the first official outing for new Leighton chief executive David Stewart, who took the job on January 1, after Wal King stepped down.
The chatter in infrastructure circles for weeks has been how Leighton will treat its $4 billion Airport Link project, its joint venture in the Middle East, which has been struggling for the past two years, the Melbourne desalination plant and the Queensland and Indonesian floods.
Against this backdrop, Spain's ACS is buying up stock in Hochtief, which owns 54.5 per cent of Leighton. The lower the share price, the more stock ACS will lap up. Once ACS gets past 50 per cent of Hochtief, it will be big changes at Leighton and perhaps more write-downs.
Frequently Asked Questions about this Article…
What triggered Insurance Australia Group's (IAG) recent earnings downgrade?
IAG cut interim earnings from $329 million to $161 million mainly because of greater-than-expected insurance losses in its British business (about $121 million) and flood-related claims. The downgrade reflects ongoing problems in the UK operation that have weighed on group profits.
How has IAG's British business affected its share price and analyst guidance?
The troubled British operation has been a persistent drag: since Mike Wilkins joined the board in November 2007 the ratio of profit downgrades to upgrades is about 10:1 (currently 7:1 for recent moves). Despite the large earnings cut, the share price fell only about 4% to $3.63, in part because the market had already factored in some downside from repeated downgrades.
Why is the Insurance Manufacturers of Australia (IMA) joint venture important to IAG?
IMA is a high‑quality, highly profitable joint venture that accounts for almost a third of IAG's premiums and contributed nearly two‑thirds of the group's cash earnings in 2010. That strong performance makes IMA strategically valuable as IAG wrestles with losses from its British business.
Has IAG tried to buy the remaining IMA stake, and what happened?
According to the article, a letter was believed to have been sent proposing to buy IMA for up to $1.5 billion, but the RACV board declined the offer and did not respond further. The article also notes commentary that IAG might have been better off spending about $1.6 billion on IMA rather than on its British expansion.
What is Mike Wilkins' remuneration and why does it matter to investors?
The article states Mike Wilkins' package includes a base salary of $1.85 million, with incentives that could boost his pay to more than $4.28 million. Investors have been focused on his performance and pay while he tries to fix the company's problems — a successful IMA purchase was suggested as a way to shift investor attention toward operational results.
What caused Leighton Holdings' profit downgrade and how large was it?
Leighton said full‑year net profit guidance fell from a previous $510 million to $480 million after a 25% drop in first‑half profit. However, the $480 million figure includes a $202 million profit from the sale of a 30% stake in its Indian business — implying a cut from an earlier comparable figure of about $710 million to $480 million (roughly a 32% downgrade). The company blamed cost overruns on the Airport Link project, issues in its Middle East joint venture (Al Habtoor Leighton), wet weather in Queensland and Indonesia, and a strong Australian dollar.
What are the key project and ownership risks for Leighton investors right now?
Major project risks include cost overruns at the $4 billion Airport Link project, struggles in the Middle East joint venture, the Melbourne desalination plant and flood impacts in Queensland and Indonesia. On the ownership side, Spain's ACS has been buying Hochtief stock (Hochtief owns 54.5% of Leighton), and if ACS increases control past 50% of Hochtief it could trigger big changes at Leighton and potentially more write‑downs.
Why did IAG's share price react relatively mildly despite a large profit cut?
The market reaction was muted — about a 4% drop to $3.63 — because investors had become accustomed to recurrent downgrades and had likely priced some of the weakness in already. The article also notes the board combined two downgrades into one announcement, which may have influenced timing and market response.
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