RSA Insurance lost its previous chief executive, Simon Lee, in December following a series of profit warnings caused by accounting irregularities in its Irish business.
The market cheered the appointment of Stephen Hester last week, but is now really a good time to buy?
A £72m black hole was found in the finances of the group’s Irish business in November. This capital shortfall was increased to £128m following a review.
When Martin Scicluna, a former chairman of Deloitte, was appointed as executive chairman to try to bring order to the group he said he wanted to turn RSA into a “well capitalised, stable group”.
The main question for investors is how will this financial black hole be filled?
RSA has already slashed its dividend in the last year. Management cut it by a third in February 2013, prompting a 14 per cent slide in its share price. There is now a real chance that the payment could be cut again.
Indeed, with potential claims for recent flooding likely to be significant, it could be argued that the chances of a dividend cut have increased as water levels rose. Last year, the wet weather resulted in £60m of extra weather-related compensation.
There are other alternatives to scrapping the dividend, such as a share issue. This could be a full rights issue to all shareholders or a placing with institutions, but this is probably a worst-case scenario. One will involve investors stumping up more cash and the other will lead to existing shareholders having their stakes diluted.
However, it is vital the black hole is filled soon. On December 16, Standard & Poor’s downgraded the credit rating of the group to A– and said the outlook was “developing”, meaning the agency could downgrade the rating by up to two notches in the 90 days from this initial downgrade.
Any further downgrade of its credit rating to BBB+ would be disastrous, as many of RSA’s customers require that their insurance is rated in the ‘A’ category to ensure financial strength. If S&P reduces its rating further, it could lead to a significant loss of business for RSA.
Alternatively, if Mr Hester makes some decisive moves then RSA could become a strong turnaround story. The group is likely to be streamlined, with some divisions sold.
Brave investors appear to have taken a punt on the shares as a recovery play, however, it is arguably more prudent for potential buyers to wait and see what Mr Hester pulls out of the bag with the results at the end of the month.