Should I Invest In RSA Insurance Group Plc?

To me, capital growth and dividend income are equally important. Together, they provide the total return from any share investment and, as you might expect, my aim is to invest in companies that can beat the total return delivered by the wider market.

To put that aim into perspective, the FTSE 100 has provided investors with a total return of around 3% per annum since January 2008.

Quality and value

If my investments are to outperform, I need to back companies that score well on several quality indicators and buy at prices that offer decent value.

So this series aims to identify appealing FTSE 100 investment opportunities and today I’m looking at RSA Insurance Group (LSE: RSA) (NASDAQOTH: RSANY.US), the general insurance company.

With the shares at 120p, RSA’s market cap. is £4,390 million.

This table summarises the firm’s recent financial record:

Year to December 2008 2009 2010 2011 2012
Revenue (£m) 7,273 7,744 8,448 9,131 9,397
Net cash from operations (£m) 527 301 296 303 303
Adjusted earnings per share 17.3p 12.2p 9.8p 11.9p 9.5p
Dividend per share 7.71p 8.25p 8.82p 9.16p 7.31p

An investor-stinging 33% dividend cut recently took the shine off a perky-looking set of interim numbers at RSA. The cold truth is that cash flows and profits couldn’t support dividend progression, look at the table — the cover was starting to get thin. Last year’s dividend cost the firm £277m, which ate up most of the net cash flow of £303m.

It’s generally hard for insurance companies to turn a profit in actual insurance operations, and a peek at last year’s cash flow statement reveals that whilst RSA saw a £165m cash inflow from operations, that figure looks small compared to £526m from investment income. From those gross figures, £201m went to tax, £115m to interest payments, and £73m to pension-deficit funding.

To generate such cash flows, there are some big-looking underlying figures for gross insurance premiums versus claims, investments, and pension funds. The risk here is that when big numbers shift a little, the little numbers they generate can move a lot.  That makes me nervous about RSA’s total-return potential over the long haul.

RSA’s total-return potential

Let’s examine five indicators to help judge the quality of the company’s total-return potential:

1. Dividend cover: earnings covered last year’s dividend around 1.3 times.  3/5

2. Borrowings: net borrowings are running around the level of net profits.  3/5    

3. Growth: flat cash flow struggles to support volatile earnings and growing revenue. 3/5

4. Price to earnings: a forward 9.5 compares well to earnings and yield expectations. 4/5

5. Outlook: good recent trading and a positive outlook. 5/5

Overall, I score RSA 18 out of 25, which suggests some potential to outpace the wider market’s total return, going forward.

Foolish summary

Although good recent trading supports a positive outlook and the valuation seems modest, RSA has struggled with profitability and cash flow in recent years. The firm’s insurance profits seem small compared to its investment profits, which complicates an investment decision about RSA. On that basis, I’m staying out of the shares.

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> Kevin does not own shares in RSA Insurance Group.