VALUE INVESTING
Royal & Sun A 'Value Bargain'

By Stephen Bland (TMFPyad)
October 11, 2002

Following my look at banks last week, I thought it would be useful, considering their depressed state and thus potential value attractions, to continue with the financial sector theme and look at insurance companies. These are considered by official sector lists to be in two sectors, namely Life Assurance and Insurance in general, though in practice many players will transact both types of business. It is though in the main emphasis of their trade that the distinction lies.

Here are the relevant companies listed in the FTSE 350:

                                 Market Value  Yield    P/E    P/TBV
                                     (£b)       (%)  
 
Aviva (LSE: AV.)                      9.3       5.8     6.6     0.9
Prudential (LSE: PRU)                 7.5       7.1     8.2     3.3
Legal & General (LSE: LGEN)           6.2       5.4     8.9     2.0
Old Mutual (LSE: OML)                 2.9       6.7     5.6     3.2
Friends Provident (LSE: FP.)          1.8       7.3     7.4     0.9
Royal & Sun (LSE: RSA)                1.3      14.2     2.6     0.4
Jardine Lloyd Thomson (LSE: JLT)      1.2       3.2    16.2    18.2
Britannic (LSE: BRT)                  0.5      11.4     6.4     0.6
St James's Place (LSE: STJ)           0.5       2.6     7.8     1.2
Countrywide Assured (LSE: CWA)        0.5       4.8     7.9     1.9
Amlin (LSE: AML)                      0.4       3.1     6.4     1.6
Hiscox (LSE: HSX)                     0.4       2.6     9.1     1.8
BRIT Insurance (LSE: BRE)             0.3       0.0     7.6     1.1

(Note that dividend yield and price to earnings (P/E) ratio figures are based on consensus forecasts whilst P/TBV data is from the last annual accounts)

Thirteen companies in all of which eight are in the Life Assurance sector and five in the Insurance sector. The life companies are the five largest plus Britannic, St. James and Countrywide. Royal & Sun used to have bigger life interests but its stated policy has been to divest the life side and concentrate on general insurance.

All of these are on lowish P/Es except Jardine, which interestingly is not far off its twelve-month share price high, as against most of the others which are not far off their twelve-month lows. Many of the yields are attractive too, though this does depend on maintained dividends. A few also trade below book based on the last accounts data. This will have changed with the market fall, since these companies hold large amounts of equity investments, but if anything I suspect that the P/TBV will have become lower in the bear market.

The cheapest of all, by a very long way, is of course Royal & Sun, which is on an extremely low P/E and high yield, the risk being that dividend may be cut further and that the expected earnings per share forecast fails to materialise. Additionally, it trades on a very high discount to book value, though I don't know what the current figure might be. Given the substantial fall in the share price over the last couple of years, it is possibly even more attractive than the 0.4 above.

General insurance is a cyclical business, meaning that business is not steady year by year but there are dramatic swings from good to bad. Poor years (i.e. a well above average incidence of claims due to some adverse events requiring large payouts) are followed by rises in premiums producing a few good years until the next hit and so on. The companies make it their business to know the statistical likelihood of claims, but the statistics can only tell you something about large numbers of incidents over a long time, not particular years. So what can be problematic is an unusually high series of claims events around the same period together with falling markets and it is this that has creamed Royal & Sun for example. That can put strain on the capital requirements of insurers because they have legal obligations to satisfy.

Following on from that point, in what may be a precedent for some other companies, Legal & General announced a fairly deep discounted rights issue recently to boost their equity capital. Royal & Sun has long been rumoured to be doing the same but so far has not done so though it has been raising cash by disposing of its life business.

Insurers tend to be geared plays on the market and I have little doubt that in a recovery they will show handsome gains. Nobody knows when a recovery will occur but, as with banks, there are some nice yields around, providing divis are not cut too much, to sweeten what may be a long holding period for those with patience. Clearly as with all equities, there are risks and again as with banks, if you wish to go in and are not sure which ones, or wish to reduce risk, then buy a selection. But Royal & Sun in my view stands out as the value bargain of all these by a long way. Its rating suggests it is much higher risk and that may well be the case, not easy to judge, but if it ever recovers, there may be a very large profit to be made here in time. I can't see it hanging around this sort of level for ever because the rating makes little sense. Either it will collapse entirely or produce some great profits for those prepared to take a chance and hang on.