In today’s ultra-volatile stock markets, one sector is perhaps hated more than any other: financial stocks.
You can understand much of this dislike, in Europe in particular. Many lenders’ balance sheets contain a whole load of nasties. And even although the European Central Bank cut rates yesterday from 1.5% to 1.25%, the chaos in the region could yet claim more victims.
However, in their haste to avoid dodgy banks, investors might be missing a trick. The insurance sector has been smashed alongside other financial stocks, and that doesn’t seem fair, as I’ll explain in a moment.
So if you’re prepared to take a contrary view (and that’s often a good idea), this could be your chance to snap up a real bargain or two.
Insurers are sharing the banks’ pain
Why have insurers seen their share prices fall so hard? The most obvious reason is that they are being tarred with the same brush as the banks. Investors are worried that insurance company balance sheets contain a number of toxic assets, such as dodgy eurozone debt.
Insurers also face similar regulatory issues to the banks. Banks must ensure they have enough capital to comply with the Basel II and Basel III solvency rules. Insurers have their own version of these, called Solvency II. The fear is that insurance companies – like banks – may need to raise more capital to comply with it, which could lead to more shares being issued, diluting existing holders.
On top of all that, it’s been an expensive year. A spate of natural disasters around the world has lifted claims and payouts.
So you can perhaps see why investors have been worried. But now we’ve got the chance to see how some of these firms really are faring. That’s because the latest results and trading statements are just out. And the fact is that things look a lot more promising than share prices in the sector might indicate.
A bargain stock with a huge yield
Last week I suggested that shares in ‘non-life’ insurer RSA (LSE: RSA) had dropped so far, they’d become a bit of a steal. The prospective yield, at 8.6%, is actually higher than its price/earnings ratio of 7.6.
For one of the world’s leading insurance groups, that seemed almost too good to be true. Yet the stock was continuing to fall further in the general market melee.
The good news is that yesterday’s results showed there wasn’t much to worry about. For starters, RSA is doing a fair bit more business this year. Insurance premiums received from customers were 11% higher in the first nine months of 2011 compared with the same period last year.
Even better, the firm has grown across the board, even in the UK. Motorists may not be happy about higher car insurance bills, but for the likes of RSA they’re good for profits. In fact, the firm is turning down less profitable business to get the best returns.
Non-life insurers gauge their profits using a measure called the ‘combined ratio’. To get this, you add the cost of claims received to administrative expenses, then divide by premiums received. A ratio below 100 means that the insurer has more money coming in than going out. So clearly, the lower the better.
And the profit picture at RSA is looking good – despite all those catastrophe claims. Assuming “normal” weather over the rest of this year, its 2011 combined ratio will be below 95. That would be the best result for five years.
There’s also good news on the balance sheet front. RSA’s capital position remains strong. 89% of the group’s total portfolio is invested in high quality bonds and cash. Just 1% is in peripheral eurozone sovereign debt.
All told, the net asset value (NAV) works out at 101p per share. Again, compared with NAV, the stock is trading at its cheapest for five years. Yielding two-thirds more than the UK’s current inflation rate, RSA looks even better value than it did last week.
Aviva turns in a less impressive performance
We also had results yesterday from other type of insurer – in ‘life’ assurance. Three months ago we tipped Aviva (LSE: AV), which used to be called Norwich Union. Once again, the share price has been hit by the overall bad feeling toward financials. So it hasn’t joined in the market’s slight recovery since then.
In truth, the latest numbers from Aviva aren’t as good as at RSA. Worldwide total sales fell by 5%, even though UK life and pension sales grew 6%. The combined ratio has improved to 96, which is about the best for three years. And the NAV has climbed to 448p per share, over a third more than the current share price.
But Aviva has suffered from the eurozone’s woes. For one thing, the firm makes almost half its profits there. Also, Aviva has taken some hits on its European portfolio. Losses like this cut into an insurer’s capital, meaning the firm’s ‘capital buffer’ has been cut by a third.
What does this mean for Aviva? It still has more than enough capital for the moment, though the firm admits it will need to watch the position closely.
Does this change our view on the company? Clearly, if Aviva does have to raise more money from shareholders via a rights issue, that would increase the number of shares in issue, which in turn, could depress the share price.
But as we pointed out before, Aviva is already extremely cheap on a p/e ratio of around six. What’s more, the prospective yield is now over 8%. And the current year dividend should be more than twice covered by earnings, which allows the company plenty of scope to pay it. With the risk of a rights issue surely now factored into the price, Aviva remains a very-high-yielding share to hang onto.
Category: Market updates