When I think of RSA Insurance Group (LSE: RSA) (NASDAQOTH: RSANY.US), two factors jump out at me as the firm’s greatest weaknesses and top the list of what makes the company less attractive as an investment proposition.
1. Cyclical industry
Deteriorating financial results have culminated in incoming CEO, Stephen Hester, setting out a turnaround agenda for RSA Insurance. Profits have been slipping for some time, as we can see in the table below. Events in the firm’s wayward Irish arm have merely brought things to a head and focused attention on the firm’s problems:
| Year to December | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 |
| Revenue (£m) | 7,273 | 7,744 | 8,448 | 9,131 | 9,397 | 9,822 |
| Net cash from operations (£m) | 527 | 301 | 296 | 303 | 303 | 456 |
| Adjusted earnings per share | 17.3p | 12.2p | 9.8p | 11.9p | 9.5p | 7.9p |
| Dividend per share | 7.71p | 8.25p | 8.82p | 9.16p | 7.31p | 2.28p |
With the full-year results statement in February, Mr Hester set out a package of reform measures including stopping the final dividend, announcing a rights issue aimed at raising £775 million, refocusing the business on the UK & Ireland, Canada, Scandinavia and Latin America, an asset disposal programme targeting £300m in proceeds, and capital actions to reduce equity and property exposure and to execute new reinsurance structures.
There’s no doubt that, under Stephen Hester. RSA Insurance has evolved into a turnaround proposition for investors, but I’m concerned about the inherent cyclicality of the financial services industry. Firms like RSA are geared to financial markets. Much of the profit that insurance companies make is derived from investments in bonds and other investments. When general financial markets take a dive, so do the share prices of the financial companies.
Right now, economies and financial markets are in good health, so the shares of firms like RSA should be riding high. The fact that RSA is in trouble makes me wonder whether it has sufficient time to catch up before the next general down-dip in the wider macro-economic cycle.
2. No dividend
It’s often said that we can judge the general health of a firm by the directors’ dividend decision. By that measure, RSA is something of a basket case. Not only has the CEO axed the final dividend completely, but the firm intends to raise three-quarters of a billion pounds in a dilutive rights issue to shore up its leaky balance sheet.
Under such conditions, without the aid of a dividend safety net, it would be nice to see the shares trading at a discount to net asset value. However, at 96p, there’s a 17% premium to the last-reported net asset value. The premium gets significantly bigger if you strip out intangibles.
That means that any justification for the firm’s current valuation depends on assessing the P/E multiple, but earnings could be volatile going forward because the whole business is subject to overhaul and reform. I’d be happier with a bigger margin of safety here, at least until the dust settles.
What now?
RSA has struggled with profitability and cash flow in recent years. Current events have brought matters to a head and now despite the concerns expressed in this article, the firm looks attractive for its turnaround potential.
