Questor share tip: Sell RSA as the spring cleaning continues

RSA

429.1p

Questor says sell

Stephen Hester’s spring clean at RSA is approaching its second spring, and the cobwebs are taking longer than expected to remove in many corners of the insurance business.

The company formerly known as Royal & Sun Alliance returned to profit in 2014, after a loss and a whopping accounting hole in 2013, yet the value of new premiums written and investment returns were weak.

RSA’s combined ratio came in at 98.8pc, meaning the firm is only just squeezing out money from the insurance policies it writes, once claims have been paid and other expenses taken care of. While this is an improvement on 2013’s ratio of 99.4pc, and suggests that the price war in UK insurance is becoming slightly less punishing on the companies involved, it means RSA is nevertheless a couple of good thunderstorms away from a loss in its core car and home insurance units.

Investment returns, which might once have acted as a safety net in a big year for claims, were similarly disappointing. The firm’s investments generated £327m, down a tenth on the previous year, thanks to pitiful yields on the relatively safe bonds that insurance firms tend to hold to produce dependable returns.

In forecasts published in December, analysts at Nomura said RSA was much more dependent on investment income than other general insurers, with 68pc of its expected 2015 income coming from its portfolio rather than its premiums.

Mr Hester is targeting returns on equity of between 12pc and 15pc, but for 2014 the reported figure was just 3.6pc, and the target appears to have slipped into at least next year, along with meaningful dividend growth.

However, there are signs of renewal within the business. RSA’s international businesses that remained after a slew of asset sales are performing well, with premiums in Scandinavia up 3pc once currency movements are excluded.

RSA’s cost-cutting drive is also accelerating, which will mean painful job reductions but £250m a year saved by 2017.

Another lift could come from the Prudential Regulation Authority, which is expected to sign off insurance firms’ final capital buffer plans later this year, as part of the Europe-wide Solvency II rule change. This long-delayed process could finally result in RSA and others freeing up capital that had been earmarked to meet the rules.

These glimmers of light at RSA could potentially clear a path for a buyout. Takeovers are being agreed in almost every other building around RSA’s new Fenchurch Street offices, from the wave of mergers within the Lloyd’s of London market to the £30bn marriage of Aviva and Friends Life.

Investors with a strong stomach may wish to hold out for an approach to take over RSA. It’s a risky strategy, however.

Meanwhile, the shares have been trading at a pricey 12.7 times next year’s expected earnings, with a dividend yield of just 0.5pc, far short of forecasts.

At about £20m, the firm is paying out roughly a third of profits attributable to shareholders as a 2p dividend this year. This sum is expected to increase to between 40pc and 50pc of profits, which themselves are forecast to steadily grow – providing there are no more skeletons in the business.

Last summer, Questor moved to a sell rating as Mr Hester’s balance sheet surgery delivered sluggish results. Yesterday’s token dividend is not enough to tempt us back into the fray, not while the turnaround plan has so many hurdles still to clear.