It’s just 10 months since RBS floated the first tranche of Direct Line shares, and a further institutional sale has brought RBS’s interest down to 48%. I bought shares in the flotation, frankly without knowing too much about the company. It was a fair bet that as a forced seller — by European Union diktat — and with sale of more stock to come, RBS would have to price the issue favourably.
So I sold out at a profit, but probably too early. The shares set a high last week, as the company delivered a reasonably good set of results. Core operating profit was up nearly 30% — partly due to lower weather-related claims — and gross written premiums (the equivalent of turnover) down 4%. But fundamentally, the results reinforced my gut feel that long term the company has nowhere to go.
With over 90% of its business in the UK, Direct Line is hostage to the highly competitive and price-transparent motor and home insurance markets. One day, somebody will launch a website that compares price-comparison sites!
A resurgent UK economy will help, but the main upside lies in cutting bloated costs inherited from RBS. That’s going well and the positive momentum will continue, with management aiming to increase the dividend — yielding over 5% – in real terms. But it’s not a share to buy and forget.
This was RSA’s first half-year results since slashing its payout last February, and the shares are still 7% below their pre-dividend cut level. But RSA’s results show why it has more opportunities for growth than Direct Line. It’s much more diversified internationally, with big operations in Canada, Scandinavia and emerging markets. Cash saved from the reduced dividend can be invested where there is more scope for growth and a better competitive environment.
Growth in net written premiums of 15% in Canada and 16% in emerging markets dwarfed the UK’s 3% to deliver an overall 7% increase. RSA is enjoying operational leverage in its emerging markets businesses, as a higher proportion of incremental income drops through to the bottom line.
RSA is also yielding over 5%, but with substantial non-sterling income its stated intention is simply to grow dividends in line with earnings. Both RSA and Direct Line are trading at a 25%-30% premium to NAV but, for me, RSA offers the better long-term prospects.
However, RSA’s dividend cut highlights the potential for accidents in general insurance shares. If you’re looking for a safer bet, I recommend you take a look at The Motley Fool’s top income stock. Just click here to download this report that tells you all about it. It’s free.
> Tony does not own any shares mentioned in this article.
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