Aviva Wields The Axe

Published in Investing on 5 July 2012

But will shrinking the insurer make it a better investment than these four rivals?

John McFarlane was appointed executive chairman of giant insurance firm Aviva (LSE: AV) on 1 July, having joined the board in September 2011.

Despite being the new broom on Aviva's board, McFarlane has already got to work cutting the global insurer down to size. He's playing Musical Chairs with the directors, plans to cut more jobs and intends to dispose of a swathe of businesses.

All change, please

Aviva has been rudderless of late -- since previous chief executive Andrew Moss left in May, the FTSE 100 (UKX) firm has been looking for a new CEO, which it expects to appoint in 2013.

In the meantime, Anglo-Australian banker McFarlane has taken the helm and is clearing Aviva's deck of incumbents. In an announcement this morning, Aviva revealed a serious shake-up of its senior management. Following this reshuffle, Aviva will have a new:

  • Director Group Transformation (David McMillan)
  • Chief Executive, UK & Ireland General Insurance (Robin Spencer)
  • Group Chief Capital and Risk Officer (John Lister)
  • Group Human Resources Director, as John Ainley is leaving the group.

As well as changing the faces at the top, McFarlane is reshaping Aviva's structure. The number of management layers will be cut to five from nine. Also, to "speed up decision-making and execution", there will be three key management groups:

1. A weekly meeting of the Office of the Chairman, consisting of these five most senior group executives: McFarlane and McMillan, plus Pat Regan, Trevor Matthews and Simon Machell.

2. A bi-monthly Group Executive meeting of the five bosses above, plus 10 other senior executives.

3. A Senior Management Group of 90 top managers that will meet twice a year.

Commenting on these changes, McFarlane said: "It is essential that we have the right people in place to implement the strategic plan and to achieve higher financial strength and performance. I am aware of past concerns regarding the frequency of management changes at Aviva; nevertheless, I judge these new appointments to be essential."

Reviving Aviva

As well as rearranging the boardroom chairs, McFarlane has decided that Aviva also needs some corporate surgery. In fact, his restructuring is so radical that it's more like operating with an axe than a scalpel.

In order to "refocus and optimise the group business portfolio" -- and make the most of its 43 million customers worldwide -- McFarlane has taken a long, hard look at all 58 of Aviva's business segments and then placed them into three groups:

1. Performing: 15 businesses with unusually high returns or growth which hold £3 billion of capital and produce £650 million of after-tax operating profit for a 22% return on capital.

2. Improve: 27 businesses that currently produce and are likely to produce returns close to the group's required return, but require significant improvement. These businesses hold £7 billion of capital and produce £750 million of after-tax operating profit for an 11% return on capital.

3. Non-Core: 16 businesses that currently produce or will likely produce returns below the group's required return. These businesses to be exited hold £6 billion of capital and produce £300 million of after-tax operating profit for a mere 5% return on capital.

By getting rid of weak, under-performing businesses such as UK Large-Scale Bulk Purchase Annuities, South Korea and small Italian partnerships, Aviva would free up billions to invest in its faster-growing, more resilient divisions.

This seems like a sound plan to me. Indeed, it reminds of my time at General Electric in the Nineties, when our renowned CEO Jack Welch placed weaker businesses into 'fix, close or sell' categories.

By making these changes, Aviva hopes to improve its financial strength -- which has often been identified as a weakness by shareholders. The group will have a new target to achieve economic capital levels of 160% to 175% of regulatory levels, given it a fatter cushion against Mr Market's periodic tantrums.

Shares still cheap

Of course, it could be argued that efficient deployment of capital is something that insurers have been doing for hundreds of years. Thus, Aviva has fallen well behind the pace by allowing corporate inefficiencies to hinder the firm's future. Perhaps this explains why its shares look so cheap in terms of their earnings rating and dividend?

As I write, Aviva shares trade at 285.5p, up 4.1p (1.5%) so far today. Thus, it seems that investors have welcomed today's news of a leaner Aviva rebuilt with fewer businesses, less bureaucracy, reduced overheads and improved financial strength (including lower capital volatility and more conservative external leverage).

Here's how the former Norwich Union compares with four of its major peers among FTSE 100 insurers, sorted from lowest to highest price-earnings ratio (PER):

CompanyShare price (p)Market value (£bn)PERDividend yield (%)Dividend cover
Aviva285.58.35.39.82.0
Old Mutual (LSE: OML)155.87.68.24.03.1
Legal & General (LSE: LGEN)127.67.59.35.71.9
Prudential (LSE: PRU)73918.911.13.62.5
Standard Life (LSE: SL)233.55.513.66.21.2
Average 9.69.55.92.1

Source: Digital Look, 05/07/12

At a mere 5.3, Aviva has the lowest forward price-to-earnings ratio of all five, versus more than double that (11.1) at arch-rival Prudential. Also, Aviva has a prospective dividend yield approaching double digits (9.8%), which is two-thirds (67%) higher than the five's average yield of 5.9%. What's more, Aviva's dividend is covered twice by earnings, so it looks safe -- for now, at least.

In my view, Aviva's attractive fundamentals -- together with today's announcements -- make its shares a solid buy for value investors and dividend devotees. These are shares to tuck away, sit back and watch the income roll in.

Lastly, the UK's biggest and best investor, Neil Woodford -- who looks after £20 billion of our money for fund manager Invesco Perpetual -- likes to buy only the very best businesses. To find out which great British firms Woodford loves to own, read Eight Shares Britain's Super-Investor Owns.

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More from Cliff D'Arcy:

> Cliff does not own any of the shares mentioned in this article.

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Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

thebuffoon 06 Jul 2012 , 7:32am

The former Commercial Union, General Accident &Norwich union, Cliff!

Good article.

This is another example of why you should buy solid companies like this when they are out of favour.

We all know about Marconi, but they didn't stick to their knitting. Good solid companies will very nearly always sort out their problems. The ones that don't are almost all undone by new technology coming along.

Aviva won't suffer that fate.

Buiffy

AlysonThomson 06 Jul 2012 , 12:48pm

Yeah, you're right about the Group's makeup, Buffy.
I look forward to my shares rising in price and maybe dividend payments getting higher?
Sounds like he's doing a good job.

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