Car and home insurer RSA (RSA) has fallen 13% to 118.4p as investors dump the stock after the £4.3 billion cap slashed its dividend by a third.


The final dividend has been cut to 3.9p a share, paying out 7.31p a share for the full year, down from the expected 9.3p. It also expects to make a similar reduction to the 2013 half-year payout.


RSA, which owns More Than, has cut its dividend because of lower bond yields which have reduced earnings by £200 million. 'The payout ratio was approaching 95% and this gave little scope to grow the business even if earnings would recover as we anticipated,' says Panmure Gordon analyst Barrie Cornes.


The dividend cut caught some off-guard. Only yesterday, Berenberg Bank said in a research note that it believed RSA was set to deliver ‘attractive and stable shareholder returns through high dividend distributions’, setting a 153p target price.


A closer look at the market forecasts shows that the dividend cut should not have come as such a surprise. RSA was trading on 6.9% prospective dividend yield with the anticipated payout only covered 1.16 times by forecast earnings per share.


A general rule of thumb is that investors prefer companies to have at least twice as many earnings per share as the dividend. Some large caps aim for 1.5 times dividend cover, but anything below this is the 'danger zone' where a slip-up in trading could make the level of dividend payout unsustainable.


Panmure Gordon has switched from 'hold' to 'sell' with a 120 price target. It expects 6.1p dividend for 2013 which equates to a 5.2% prospective yield. Barrie Cornes says: 'Given that 12 months ago RSA flagged that the rate of dividend growth was to reduce from c6% to c2-2.5% we view the cut as very disappointing given that nothing has materially changed over the last 12 months.'


Espírito Santo analyst Joy Ferneyhough believes conditions will not improve for RSA. She says: ‘Underlying earnings are likely to come under increasing pressure from investment income headwinds and potentially dwindling reserve releases.


‘The dividend cut will likely draw questions on a number of areas, not least longevity of reserve releases, pricing outlook and capital position. This is likely to have opened a can of worms and we expect the share price will suffer as a result.'



Issue Date: 20 Feb 2013