Right Royal bargain in view

IT IS the time of year when fund managers crowd the hospitality tents at Henley and Wimbledon and brokers take their holidays before the mid-year results come out. Particularly for insurance companies that report quarterly earnings, it is one of the rare quiet moments to look at the shares - and it is in such moments, rather than the flurries that precede and follow results, that the outsider can find cheap stock.

Investors considering Royal Insurance have to brace themselves to contemplate a murky past, which since 1990 has included a cut in the dividend, heavy losses on mortgage indemnity insurance, winter storms in Europe and a succession of problems in North America. It can be argued that disasters never hurt insurers that much, because they provide an excuse to force up premium rates, but Royal was more exposed than most.

In the dark days of the early 1990s, tales of archaic working practices and heavy administrative overload emanated from its Liverpool headquarters. The company admits that after the 1990 storm it had to move staff around the country to cope with the flood of paperwork.

After the arrival at Royal in 1992 of Richard Gamble from British Airways as chief executive, what had hitherto been a typically introverted and feebly managed insurer began to appear to be better run. Roy Randall, the company's head of investor relations, says: "We now know within three days of the end of every month what our premium income is in every area of our business. As Mr Gamble puts it, everyone in insurance has got cycles, you just have to manage them."

Pricing cycles clearly still affect Royal. Premiums in the UK non-life insurance business have been on the downturn for over a year now that competition in such areas as motor insurance has hotted up, led by the telephone-based Direct Line, but also by Royal's competitor, The Insurance Service. But profits at the pre-tax level are not set to fall until 1996.

The company's solvency ratio, a measure of how strongly it is capitalised, is still a little lower than at other composite insurers, but as the company's broker, S G Warburg, has noted, that makes the return on equity correspondingly high. In any case, with the economy in good shape, there is no need to be unduly worried about the downside. The rate of claims tends to be at its worst in recessions.

The case for Royal rests on the assumption that most of the downside is already reflected in the share price. The lack of diversification outside Britain and a persistently troublesome North America - more significantly the company's exposure to pollution claims in the United States - have been evident for years. As Stephen Dias, insurance analyst at Goldman Sachs, says: "There are lots of people in the institutions who were sellers of Royal five years ago and now are more senior, but don't realise Royal has changed its spots."

So poor old Royal still trades on a bigger discount to its net asset value than its peer group - the likes of Commercial Union, General Accident and Sun Alliance. Royal's underlying worth on this measure is 340p a share - compared to which the current share price looks cheap. Its life business is a relatively large part of the whole and is both unpredictable and disappointing. But Royal followers feel Mr Gamble has as good a chance as anyone of sorting it out.

Looking at shorter-term, investment-related factors - and after all, an insurer is just an investment trust with an expensive hobby - some in the market seem to have ignored an interesting fact. Royal, whose large American presence makes it a big buyer of American bonds, has done very well out of the rise in the US bond market this year. Anyone feeling pessimistic about the US economy and expecting the Federal Reserve to cut interest rates in the near future should be particularly keen on Royal.

Another fillip may come later in the year if legislation is passed to reform the regime for insurers faced with industrial site clean-up claims. These are a big worry for Royal, like any insurer active in the US, especially one whose clients include General Motors. But the current "polluter pays" legislation results in so much litigation that $70 in every $100 claimed goes on legal fees, so there is a following wind in Congress for reform.

"Royal is not alone. When you get an industry-wide problem, you eventually get an industry solution," says Mr Dias. Any relaxation of the rules - which Royal claims require every site to be cleaned up sufficiently to grow organic vegetables - would be welcome.

It all means there is scope for a re-rating from the current forward multiple of six times prospective earnings. In the meantime, a buyer of Royal shares enjoys a yield 20 per cent higher than the market offers and the prospect of rapid growth. There is plenty of room to grow from the artificially low level of payout that is the consequence of the 1991 cut in the dividend - a measure that hardly looks necessary with the benefit of hindsight, except as a signal that change was coming...

Activities Life and general insurance.

Share price 309p Prospective yield 5.6% Prospective price-earnings ratio 6 Dividend cover 3.5 1993/4 1994/5 1995/6* Premiums written pounds 5.1bn pounds 4.8bn pounds 4.9bn Pre-tax profit pounds 143m pounds 401m pounds 435m Profit after tax pounds 145m pounds 347m pounds 325m Earnings per share 23.0p 52.7p 49.6p Dividend per share 7.5p 12.0p 14.0p (*forecast by NatWest Securities)