Just What's Wrong With Aviva?

Published in Company Comment on 27 September 2011

The market thinks it's a basket case. Is it correct?

Many of us bought it as a value play. But shares in Aviva (LSE: AV) have persistently drifted downwards until it is now trading at basket case levels, with a P/E of 5 and dividend yield of over 9%. That's well into what is usually too-good-to-be-true territory. So perhaps it's time to ask the question: is there a fundamental problem with the company?

The shares lost another 10% last week. Around half of the losses came on Wednesday when negative comment from broker UBS coincided with the shares going ex-div. One side effect of such a high yield is that going ex div is more significant. More losses followed with the market turmoil on Thursday.

As I write things are looking up a little. So far this week they have recovered a good proportion of last week's losses, at 295p. Otherwise the yield would be an even more dangerous looking 10%.

Let's look at the case against Aviva.

Europe

Aviva's European focus was the trigger for last week's falls, as UBS placed it on a list of least preferred stocks in the sector due to its exposure to the Eurozone.

Half of Aviva's business is in continental Europe, where its strategic focus is on the mature markets of France, Spain, Italy, Ireland and Poland together with the emerging markets of Turkey and Russia. I suppose focussing on basket case countries is one way of becoming a basket case yourself, and it may well be true that Aviva would be one of the biggest losers if the whole Euro project blew up. But in those circumstances it would seem to be a case of it being more dead than most.

Though European sales were down in the first half of the year, the company improved operating profit in the region by 21%, by targeting value rather than volume. And it sees an increasing realisation by consumers in the region that governments will not be able to fund their retirement, with savings rates up 12% since 2008.

Nor does its balance sheet exposure to dodgy European debt seem excessive. Total exposure to government bonds for Greece, Spain, Portugal, Ireland and Italy was £1.4bn, or 1.2% of shareholders' funds.

Business Model

Aviva is the only remaining large UK composite insurer, with about three quarters of revenues and profits coming from the life assurance side. 

RSA (LSE: RSA) made an unsuccessful pitch at acquiring Aviva's general insurance business last year, and there may be some value in a break up, but it is hard to see how Aviva's composite business model can have held back its valuation to a great extent. Aviva has argued that there are synergies in allocating capital between the two sides of the business.

More significantly, Aviva's CEO has been working on restructuring its complex array of businesses and geographies. The new strategy is to focus on twelve core markets which generate over $100m of profits, plus China and India. 

The company says it is on track to deliver £400m annual cost savings by 2012, and it has sold non-core operations in the form of the RAC and its majority in Dutch insurer Delta Lloyd. But there is no obvious buyer for the disparate Central European and Asian businesses which have "For Sale" signs hanging over them. Perhaps the market is punishing delay in execution of the strategy.

Management Changes

The company lost some key executives, including the head of its UK business earlier this year, and has been through a protracted process of appointing a new Chairman designate. But an appointment has now been made, to take effect when the existing chairman retires next year, and in the meantime respect for the group's CEO Andrew Moss seems to be growing as the business is restructured. 

If management changes were a source of share price weakness, that effect should now be diminishing.

Sectoral Issues

Of course a slew of issues weigh on shares in the whole sector, which is trading on historically low levels. But does not explain Aviva's rating relative to other big insurers.

CompanyMarket CapP/EDiv Yield
Aviva£7.9bn5.09.2%
Legal & General (LSE: LGEN)£5.4bn6.55.2%
Prudential (LSE: PRU)£13.9bn8.84.4%
Standard Life (LSE: SL)£4.5bn10.66.7%

Chief amongst the sectoral woes are the consequences of the proposed Solvency II directive, and the Retail distribution Review (RDR).

The former will require insurers to hold more capital and impose onerous reporting requirements. But Aviva has £4bn more capital than its regulatory minimum, and its restructuring seems to have included rationalising legacy computer systems to streamline reporting.

The RDR's requirement to remunerate IFAs by fees is expected to depress sales of long term insurance products. But Aviva has an impressive stable of bank intermediary relationships, including HSBC (LSE: HSBA), Barclays (LSE: BARC), RBS (LSE: RBS) and Santander so the impact should be at least no greater than the average.

Valuation

Aviva's valuation also looks remarkable cheap against its net assets: a discount of 30% to IFRS NAV and 50% to MCEV embedded value, which includes the future profits from policies already written. I have struggled to find convincing reasons for this under-valuation.

So I was happy to top up my shares last week. And I took some comfort from CEO Andrew Moss buying £77,000 worth of shares at 309p recently, taking his holding to over £1m.

More from Tony Reading:

> Tony has shares in Aviva.

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Comments

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rober00 27 Sep 2011 , 4:55pm

I stopped at 5% of my portfolio but only because of other investment commitments.

At these levels I am with Stephen Bland on this one!!

DIYIncome 27 Sep 2011 , 5:20pm

Tony

Thanks for the reassurance. I'm holding the max I am comfortable with (and would buy more otherwise).

ANuvver 27 Sep 2011 , 8:09pm

I reckon the past two trading sessions' action in AV confirms that fear is driving and fundamentals (insofar as they are penetrable to a non-specialist) have been dropped off to hitchhike. The slightest sense - misplaced or not - that perhaps the wheels aren't going to come off the European debt market is enough to shift the stock from intensive care onto the wards. This on low-volume cautious optimism.

We still seem to be range-trading between 5 and 5,4 for now. If some form of action materialises from European governments over the next six weeks, we'll break upwards. If not...

Incidentally, for all that a lot of price action seems to be governed by economists pessimistically second-guessing politicians, bear in mind the massive impact of practical diplomacy on the processes in play in Europe. A diplomat is someone who will only tell you things are going to change in their memoirs, thirty years after the changes have become a matter of history.

I think the FDP will rattle their sabres, but Merkel will push through the first round of legislation. Once that happens, the others will fall into place quite quickly.

pagain 28 Sep 2011 , 9:55am


Well, here is Anthony Hilton's view (about Lloyds, but equally applicable to Aviva)

http://www.thisislondon.co.uk/markets/article-23991452-back-office-growth-gives-lloyds-a-fright.do

If correct, insurance companies will move to long term lower profitability.

Graham01 28 Sep 2011 , 10:35am

Does anyone have any idea who is most active in insuring/issuing the CDS for government bonds, especially Greece?

If Greece has a "structured default" who needs to pay out?

4spiel 28 Sep 2011 , 12:50pm

Even if the dividend declined to 6% over time the shares are still cheap and reassurance when the CEO buys 77000 does one need any more. I bought more at 330 and at 312 . They sell new policies at current underwriting values. If there is underperformance they reduce the payout end of term so this is not a speculative business -it is very pedantic and income flows relatively stable as you can get.

Jimi97 28 Sep 2011 , 5:29pm

I still do not understand why the management abandoned the value of the old Norwich Union name. Name recognition is a key element in winning business - I for one have not given them any business since the name change. Insurers have probably had their emotions and affections surgically removed, but not their customers.

Chairman2 28 Sep 2011 , 7:59pm

I have said it before but will say it agin Private Investors are buying in droves, Instutional holders continue to sell.

Given that professional investors have a massive information
and insider track advantage over PI's, they are huge market
players and PI's are bit part actors,and that most PI's admit
they cannot understand insurance company accounting this
situation is in itself a major bear case against Aviva.

Home cooked analysis and value calculations is no substitue
for appreciation of what 'the market' view is. A share is only
worth what someone will pay to buy it from you - a changing
figure but the reality.

Saesneg 28 Sep 2011 , 11:34pm

Maybe someone can explain to me why the P/E is said to be 5.0 in this article and is listed as 10.54 on the FT site. As someone new to investing, am I missing something?

Thanks

phil200 29 Sep 2011 , 8:23pm

Hi Saesneg,

The P/E can be based on the historic P/E, rolling P/E or projected P/E. Same principle applies for the dividend yield.

The E of P/E can also be based on the basic EPS, adjusted EPS or diluted EPS.

Taking the data from sharelockholmes, the P/E’s are all around 6.

Looking at the RNS for the 6 month results, “Operating earnings per share” is reported as 29.1p, which divided into the share price of 312p gives around 10.7 so it may have come from here. AV’s accounts are too complicated for me to comment further.

The only real way is to look at the annual report and work it out yourself, or compare the data from several providers e.g. Fool, London Stock Exchange etc.

This is a good article and there are others if you have a search :
http://www.fool.co.uk/news/investing/investing-strategy/2010/08/31/a-valuation-toolkit.aspx

Phil.

TonysView 08 Oct 2011 , 5:49am

Echoing someone else's question here... any one know Avivas exposure to CDS particularly of Greek and Italian debt?

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