Stellar first quarter

Last month Royal & SunAlliance (RSA) released an impressive first quarter result. Gains were achieved in nearly every significant reporting category. RSA attributed the solid performance to their balanced portfolio of products, operational improvements and strong underwriting/claims discipline. Given the results currently being achieved, and the quality of the management team, we believe it is only a matter of time before the shares undergo a re-rating.

Despite these results, RSA has been somewhat disappointing during its time in the Fat Prophets Portfolio. While displaying positive signs, a lasting re-rating has proven elusive. We are optimistic that support between 74p and 70p will provide the shares with a base prior to a turnaround taking place. A sustained break above trend-line resistance at 78p would be an early indication that a recovery was underway.

Strong performances from all core businesses enabled RSA to grow net written premiums (NWP) by 24 percent to £1,492 million. Excluding timing differences related to Munich Re transfers, NWP still rose 7 percent. Operating profit increased an impressive 95 percent to £160 million, once again beating market expectations by a wide mark. RSA's core operating ratio (COR), which measures claims as a percentage of premiums, improved significantly by 300 basis points to 91.2 percent. Group COR made an even larger gain, increasing from 101 to 94.8 percent.

Within the insurer's core group, all areas produced sub 100 percent COR's. The UK's 'commercial' business delivered solid results, reducing COR by nearly 7 percent, while the 'personal' division's 'MORE THAN' business delivered a 14 percent gain in NWP. In Scandinavia, NWP also rose 14 percent and COR improved to 88.4 percent despite the impact of heavy storms. The International division continued the run of improved performance as NPW increased 7 percent to £301 million and COR improved to 97 percent.

The US market has been problematic for RSA for several years. Therefore, we were encouraged that the group is continuing to reduce exposure to that market. RSA reduced open claims by 11 percent and collected reinsurance of US$244 million. Following the quarter-end, RSA settled a legal case with PNC Bank, and as a result reduced their exposure to on-going Student Finance litigation by US$129 million. We are very encouraged by this progress although RSA point out that the US business still has exposure to various additional risks. The sale of the group's profitable 'non-standard auto-insurance' line is progressing as planned.

The company's operational improvement programme has continued to return solid results. To date the programme has delivered over £200 million in cost savings with RSA anticipating an additional £70 million to come. The programme has also bolstered the efficiency of the company's underwriting/claims processes, and enhanced business retention, further improving profitability.

The progress that RSA are making in de-risking the company, improving the group's capital base and implementing operational improvement has also strengthened the company's financial foundations. As a result, Moody's upgraded RSA's subordinated debt to investment grade during the quarter.

At current levels we believe insurer's valuation fundamentals are undemanding. RSA trades on a price earnings multiple of 8 times, while offering a healthy dividend yield in excess of 6 percent. We also note that the shares are currently priced at a discount to the company's net asset value of 96p.

At the time of our last review in FAT70, RSA's prospects of a turnaround appeared sound, with upward momentum building and sentiment improving. However the recovery proved short-lived and the shares have subsequently retreated. Nevertheless we remain of the belief that substantial value will be restored in time. Therefore, RSA will remain firmly held within the Fat Prophets Portfolio.