The transformation at Royal & Sun Alliance has rewarded investors. Can the improvement continue?
Turn-around situations can be very profitable for investors. One such has been at insurance giant, Royal & Sun Alliance
(LSE: RSA)
. Those Fools who bought the shares 18 months to 2 years ago have been richly rewarded.
The 3rd quarter results released this morning show that the turn-around efforts are still having positive effects. The operating result is 21% higher than for the same period last year. Profit before disposals and the pension scheme change is up 40%.
The transformation is continuing. RSA is withdrawing from the US and announced in September that it had agreed to sell its US subsidiary. There are still formal requirements it needs to comply with, but RSA is hoping that the sale can be finalised by the end of the year. RSA has also delisted from the New York Stock Exchange.
Insurance companies have two sources of income. One is from the underwriting business and the other is from an investments business. The usual metric to determine the profitability of the underwriting business is the "combined ratio." This is the ratio of money paid out on claims plus expenses, divided by the amount received from premiums. A ratio under 100% means the company has made an underwriting profit.
In the first nine months for this year, RSA had a combined ratio of 93.1%, 0.5 points better than for the same period last year. The company is expecting a combined ratio of 95% for the full year. The underwriting result was 8% better than last year. The investment result isn't quite as good. It's 3% higher than the same period last year.
Can RSA continue to improve? There are risks. One is that the insurance cycle will turn. When this happens premiums will fall and RSA may suffer underwriting losses. This would not be unusual as insurance companies usually expect to have a combined ratio that is greater than 100% over the course of the insurance cycle.
The other risk is that the investment performance will wilt. Like most insurers RSA is heavily invested in bonds and as interest rates around the world rise (as they are doing now), the prices of bonds fall. How RSA's investments perform will be dependent on the skill of its managers.
However, it looks as if the market has already priced these risks in. RSA is yielding 3.3% and its forward price-earnings ratio is only 11.7. So I'm not selling my shares quite yet.
On a final note, it is interesting that the shares fell in initial trading this morning. According to one commentator, the market looked at the bottom line figure and saw pre-tax profit fall to £473 million from £583 million in the same period last year, or a 19% drop. However, the £583 million figure includes a one-off gain from the reorganisation of the pension fund. Strip this out and the 19% drop turns into 17% gain -- the market got it wrong.
