On the face of it, RSA insurance group is well thought of by investors. The business has an attractive long-term strategy that targets strong growth overseas – particularly in emerging markets – and its half-year results, posted at the start of the month, were reasonably well received by the market. Digging a bit more deeply, however, has the group really been that successful?
One way investors can gauge the success of an insurance business is to look at gross written premiums – the amount of business an insurance company actually writes. Here RSA has enjoyed some strong growth in recent years, with consensus estimates for gross premiums in 2012 up 38% from 2006 levels.
Furthermore a rising proportion of that growth is coming from the emerging markets and elsewhere overseas, which means RSA is increasingly doing business in areas of the world where the stockmarket values that business more highly.
Over the same six-year period, however, RSA’s profitability has not improved – indeed operating profit is down 9% since 2006 and the business the group is writing in emerging markets is hardly generating any profits at all.
There are good reasons for this, the most obvious of which is that RSA has been growing its overseas businesses from scratch and thus has yet to enjoy much in the way of benefits of scale. Also, the sort of costs it has had to inject mean it would have been unreasonable to expect profitability from day one. nevertheless, given the intervening period and the size of its overseas businesses now, one could reasonably expect the group to be a lot more profitable than it currently is.
A second factor contributing to RSA’s lack of profitability is that insurance companies traditionally make their money in two ways. one is by writing home, car and other insurance policies and the other is by taking the premiums they are paid for those policies and investing them in low-risk assets, such as government bonds. Unfortunately such assets are returning very little in the current environment, which has clearly had a knock-on effect on insurance companies’ balance sheets.
Even so, ways do exist to enhance returns in such an environment – the classic example being share buybacks. However, RSA’s share count has actually been growing steadily in recent years and is now up by a fifth since 2006 as many investors have exercised scrip dividends, which allow them to take equity instead of cash. As a result, RSA’s earnings per share number has fallen 27% over the last six years.
Another way to measure the success of an insurance business – and the one we ourselves favour – is to look at its tangible book value per share. What are the tangible assets? In the normal course of events, a business will hopefully make profits and will then have the choice of retaining those profits or paying them out in the form of a dividend.
Over time, an insurance company’s tangible book value ought to grow but that has not been the case at RSA. In 2006, the group’s tangible book value per share was 79p but consensus estimates have that falling some 10% to 71p this year. A big reason for that – other than the rise in the company’s shares and it’s elevated dividend policy – is RSA has spent a significant proportion of its profits on a number of acquisitions.
Not all these have, if we are kind, been bargains and they also introduce the somewhat nebulous issue of goodwill onto the balance sheet. Certainly goodwill is not a tangible asset and, while it may or may not have some value – and clearly management believe it does – history suggests investors should be sceptical.
One final way to measure success, of course, would be on share price and, having done very well to bring the business back from the brink in 2003, the RSA management team initially saw some strong share price appreciation. Since 2006, however, the shares have done very little, essentially reflecting the lack of progress in many of the financials detailed above.
So, while this is a business that is seen by many market watchers as pursuing the right strategies, here on the value perspective we would question whether that is really the case, and does it actually deserve the level of respect and loyalty from some shareholders it appears to command at present?