As the first chapter of a possible defence document, RSA’s first-half results read very well. After 18 months of cutting costs and flogging small units overseas, chief executive Stephen Hester has something to shout about. Unlike a year ago, the company achieved the basic requirement for a general insurer of making an underwriting profit.
Throw in a reasonable investment result, and RSA smashed City forecasts at the level of operating profits – £259m was about £50m better than expected. Hester’s boast that RSA is “a company that is getting more valuable” is plainly correct.
So what’s a fair price if Zurich, or anybody else, wishes to bid? There are several ways to approach the question. All suggest a bidder would have to offer at least 550p per share just to be taken seriously.
Consider that RSA, on current form, should be able to boost earnings per share from a projected 30p this year, according to City estimates, to 40p in 2017. The task doesn’t look terribly demanding. RSA’s combined ratio – claims versus income from premiums – was 97% in the half year. But Aviva’s general insurance business, which has been through the restructuring wringer for rather longer, achieves 93%.
If RSA could match Aviva’s performance by 2017, underwriting profits would more than double. In the meantime, the reappearance of rising interest rates would improve all insurers’ investment income. So 40p of earnings in 2017 is a reasonable target. At 13 times earnings, a “fair” value for RSA’s shares would then be 520p; at 14 times, it would be 560p.
There is, of course, a risk that those earnings never materialise. Insurance is volatile and setbacks happen – that’s why the industry exists, after all. But if there is a sporting chance of RSA, which was trading at 440p before Zurich appeared, getting to 550p under its own steam within 18 months, why sell for anything less today? Shareholders can only sell their company once, after all.
Another way to digest the valuation conundrum is cruder. The stock market thought RSA was worth 440p before Zurich said it was contemplating a bid. Where would the share price be today if the Swiss had been silent? Call it 460p after yesterday’s encouraging numbers, add a traditional 30% takeover premium, and you get about 600p.
At that sort of price, RSA would probably be obliged to surrender. Is Zurich prepared to go that high? Possibly not. Zurich’s own half-year results on Thursday were weak, suggesting its shareholders might kill a £5.5bn offer and tell management to concentrate on fixing what they own already.
But that’s not Hester’s problem. RSA, in the very long run, will probably be swept up in the consolidation wave. But the short-term objective is to make independence seem a credible alternative. On yesterday’s evidence, RSA is getting there.
Rio Tinto’s Sam Walsh can afford to hike dividends
Has Rio Tinto chief executive Sam Walsh noticed that a still-raging storm in commodity prices has just reduced the miner’s half-year earnings by 43%? In the face of such destruction in the profit line, Walsh hiked the company’s half-year dividend by 12% and committed to spend another $1bn buying back shares.
Typical mining machismo? Actually, no. Rio is one of the few big miners that can afford to be generous to its shareholders these days. As Walsh was at pains to point out, Rio’s numbers add up even in a colder climate for miners.
The company generated $4.4bn of cash in the first half of the year, enough to cover the $2.2bn cost of the dividend plus $1.2bn of maintenance capital expenditure. Nor is the debt burden heavy, relatively speaking. Net debt was $13.7bn at the half-year but this is a large company.
The arithmetic would look less robust if commodity prices were to take another lurch downwards. But, at the moment, one can understand why Rio – controversially – wants to keep digging.
Iron ore was the world’s greatest product a couple of years ago, when China’s steel mills couldn’t get enough of the stuff and were willing to pay $150 (£97) a tonne. But even at today’s $57 (£37) a tonne, margins for low-cost producers like Rio are attractive. The company can dig the product out of the Australian desert for $15.20 (£10) a tonne and land it in China for an all-in cost of $29 (£19) a tonne. Not bad.
Rio, and iron ore twin BHP Billiton, would surely have invested less in iron ore in recent years if they had sniffed the coming weakness in China. For that, they can be blamed. But it is yesterday’s story. Right now, keeping iron ore production at high volumes and waiting for high-cost rivals to close capacity is the correct strategy, even if Ivan Glasenberg at Glencore disagrees.
