Investment Column: Problems mount for Royal & Sun

Growing pains make Innovation one to avoid; Best to hold on to Xstrata despite fears of a wobble
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The Independent Online

Royal & Sunalliance faced insurance pay-outs on the 11 September attacks and asbestosis claims on one side of its business, falling confidence in the life insurance industry on the other, and collapsing stock markets affecting both. It has been a rough few years for shareholders. Now the company has sold its life insurance business at the bottom of the market, to concentrate on a general insurance industry that looks to be past the top of its cycle. It is not going to get much easier even from here.

Royal & Sunalliance faced insurance pay-outs on the 11 September attacks and asbestosis claims on one side of its business, falling confidence in the life insurance industry on the other, and collapsing stock markets affecting both. It has been a rough few years for shareholders. Now the company has sold its life insurance business at the bottom of the market, to concentrate on a general insurance industry that looks to be past the top of its cycle. It is not going to get much easier even from here.

Reshaped RSA is a well diversified general insurer, operating in both the commercial and personal insurance markets across the UK, US and Scandinavia. It also runs smaller business across Europe, the Middle East and Asia.

Continued uncertainty in the US, where RSA's costs have soared, could dog the group for some time. The asbestos claims continue to flood in, and it is unclear whether RSA will be forced to cough up yet more for the World Trade Centre loss, as US property tycoon Larry Silverstein tries to convince judges the attack constituted two insurable events, not one.

While the company's capital position looks much more stable, thanks to the £850m sale of the life business last month and a £960m rights issue at 70p last year, there is now the threat of falling insurance premiums across the industry, which could eat into RSA's currently healthy margins. Yesterday's interim figures for the reshaped business showed an operating profit of £301m, down from £351m but significantly higher than forecast, and management was confident premiums will stay high, if not at their highest, for a while to come.

After the recent drift in the group's share price, RSA is arguably undervalued on a shorter view, so for those who are looking to exit there might well be a better opportunity than at present. But this is not a stock which is easy to commend to investors over the long term. New investors looking for exposure to the insurance sector should look elsewhere unless they have a very strong appetite for risk.

Growing pains make Innovation one to avoid

Eighteen months on from the rights issue that rescued The Innovation Group from dot.com bust, the software group is a focused, cash generative company. It has scaled back to concentrate on software and services which help improve efficiency in insurance and related industries, and has an impressive list of clients which includes Royal & SunAlliance, Axa and BMW. But the company is not growing.

Quarterly financial figures yesterday were disappointing. They showed the effects of the loss of a significant customer for its outsourced insurance services division, and suggested that the lost business was proving hard to replace. Sales in the technology solutions half of the business also missed Investec Securities' forecasts.

The stock was up 0.5p to 22.75p, though, on the promise that it will hit market forecasts for the full-year and confidence that an improved order book will turn into profitable business.

The presence of Robert Bonnier, the Scoot.com founder, on The Innovation Group's share register generated plenty of excitement last year, but this high-stakes investor is not likely to prove a benign influence from here, since his 18 per cent stake will probably be unwound eventually. We told investors to hang fire in February when the sales recovery was in its earliest days. The slower than expected progress since then justifies keeping one's powder dry still.

Best to hold on to Xstrata despite fears of a wobble

Xstrata is a work in progress. It floated in 2002 having bought a load of mining assets, and its chief executive, Mick Davis, is intent on building a diversified group to take on the giants of the industry. After the transformative $3bn acquisition of MIM last year, he has extended the portfolio of assets from thermal coal (used in power stations) into coking coal (for the making of steel) and copper, and reduced dependence on South Africa. Now he is looking in South America and for a player with big reserves of copper. On current reserves, Xstrata runs out of this increasingly precious metal next decade.

The acquisition of MIM is bedding down well, Xstrata's results showed yesterday, with efficiency improvements coming through. The demand for copper from China has pushed that metal's price sky-high this year, and Mr Davis said high commodities prices are set to continue into next year.

While the Chinese growth story is a long-term one, there could be a wobble next year, and there may be better times to buy into the mining sector. Xstrata itself is returning cash to shareholders rather than rushing to acquisitions at a possible cyclical peak. But the shares, at 765p, still sit at an appropriate discount to the more diversified, less risky miners. Hold.

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