Share tip of the week: Extreme caution will pay off for insurer

The cost of insurance is rising. That's great news for this property insurance specialist, which derives around two-thirds of its income from the US, compared to 11% from Britain.

The cost of insurance is rising. That's great news for Omega, a property insurance specialist for small- and medium-sized businesses in North America. Around two-thirds of its income comes from the US, compared to 11% from Britain.

Omega also offers a small amount of marine, motor, professional indemnity and directors' liability insurance. It recently spent £18.5m increasing its share by 18.3% to 34.7% in the Syndicate 958 of Lloyd's of London.

So what are Omega's strengths? Key players such as AIG have scaled back operations, while many others don't have the funds to expand as premiums rise. Yet Omega increased capacity by raising £124m at 140p a share in January. It is now reaping the rewards. The company is expecting to deliver 2009 earnings per share (EPS) and dividends of 12.1p and 8.2p respectively, rising to 14.5p and 10.7p in 2010.

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This puts the stock on miserly price/earnings (p/e) multiples of 9.8 and 8.2. It also offers a 6.8% yield. Normally, such a high yield would raise alarm bells. But in Omega's case the payout looks justified, given its conservatively managed balance sheet. Furthermore, on 29 October the board said that "performance continues to be strong and in line with expectations".

Omega Insurance (LSE: OIH), rated a BUY by Numis Securities


The $628m investment book is in good shape, too. Sure, returns were only 0.7% in the first half of 2009, but that reflects the group's detailed attention to capital preservation. By the end of June, Omega had parked its funds in a basket of top-quality, fixed-income instruments, of which 85% were either AAA credit-rated bonds or cash. This extreme caution has seen it miss out on the recent equity rally but when the next correction arrives, investors will be grateful.

But it's not without risks. Like many other firms in the industry, results can be blown apart (as they were in 2008) by unexpected natural disasters. Examples include hurricanes such as Ike and Gustav, or another financial crisis hitting investment returns. Omega is also exposed to foreign-exchange fluctuations (in particular a weakening dollar) and claims from clients who are being hit by class-action lawsuits that allege director negligence.

However, since the collapse of Enron in 2002, Lloyd's insurers have decreased their exposure to such claims, and the fallout from the latest banking crisis is expected to be "relatively modest". Finally, the recent liquidation of America's biggest lender to small- and medium-sized firms, CIT, could disrupt Omega's core client base in the short term.

Nonetheless, with a respected brand and rock-solid investment book, I rate Omega on a 1.2 times 2009 net asset value multiple, or around 140p per share. At current depressed levels the stock could also become an acquisition target again, especially after Omega rejected a takeover approach back in April 2008. The next trading update is scheduled for 19 November and Numis Securities has a 160p price target for the shares.

Recommendation: BUY at 119p

Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments

Paul gained a degree in electrical engineering and went on to qualify as a chartered management accountant. He has extensive corporate finance and investment experience and is a member of the Securities Institute.

Over the past 16 years Paul has held top-level financial management and M&A roles for blue-chip companies such as O2, GKN and Unilever. He is now director of his own capital investment and consultancy firm, PMH Capital Limited.

Paul is an expert at analysing companies in new, fast-growing markets, and is an extremely shrewd stock-picker.