Stephen Bland recaps his 'farm bet' on Aviva (LSE: AV.)
Aviva (LSE: AV), the composite insurer that takes the majority proportion of the Value Portfolio (VP), has just issued half-year results to 30 June so in view of the fact that I am close to farming it here, a review is probably apposite.
First a few facts about the VP upon which I report quarterly so the next one will be end September. The current value of the four shares held is £69,819 and Aviva within that is worth £45,377 making it 65% of the total. The average purchase price of the several tranches in which I added this share is 390p including all costs so at the present 315p it is down 19%.
The background to why I invested such a large proportion in Aviva is that for a long time I have believed that it is seriously undervalued, principally on the premium yield at which it has traded against the FTSE 100 of which it is a constituent. Being a big cap and therefore in my view intrinsically lower risk, I have relaxed my usual value criteria, trading that off against sheer size.
Looking historically at known figures, I see that the FTSE 100 as of yesterday's close yielded 3.67%. Aviva with today's same-again 10p per share interim dividend has a rolling twelve-month total of 26p per share making an 8.3% historical yield. That is a very large yield premium. Looking ahead this continues to be the case to the extent that analysts' figures can be dependable with the 26.4p payout forecast for 2012 putting it on a forward yield of 8.4%.
I have maintained that this situation cannot continue forever and so the yield premium must at some stage narrow considerably. That could happen by a dividend cut, a strong price rise, or, rather unlikely, a major fall in the FTSE 100 thereby driving up its yield considerably without a similar proportionate fall for Aviva. Because the company cut its dividend in the recent recession, specifically from 33p to 24p per share between 2008 and 2009 from which it has risen slightly to the 26p per share paid in 2011, I have held the view that further near-term cuts are unlikely, though this can never be ruled out.
There is a further possibility that I should point out here, which is that this level of yield premium does in fact go on forever or more practically, for such length of time that even if it does ultimately out, the annualised capital gain achieved makes for a very modest return. But in that case at today's price there is already an 8% annual return built in by way of the yield assuming dividends are not cut, so it would not take a huge annual average capital gain to make for a decent total return.
So what's in these accounts? Well the disappointingly held dividend of 10p per share is one obvious feature, particularly for me whose main value case rests on dividends. Would have been far worse though if it had been cut.
An earnings loss of 26.0p per share was made against a 4.1p per share profit for last year's interim comparative. Disastrous on the face of it but closer analysis reveals that this is due mainly to writing off £876 million of US goodwill and consequently not a cash cost. However, even before this deduction operating profits including restructuring costs were down 10% to £935 million due the company says to the sale of the RAC and other reasons. The restructuring costs are part of a plan to reorganise the business on to a much more profitable footing.
Aviva quotes net asset value on an accounting basis at 395p per share against 435p as at 31 December 2011 but there is a large intangible assets element there. My calculation of net tangible assets per share is 277p so Aviva is trading over that. Not an asset play then but that was never part of my case for the share anyway.
For what it's worth Aviva quotes the MCEV net asset value per share at 421p. Sounds nice but this is a specific insurance business measure of asset value and therefore not comparable with other businesses for a value assessment so I pay little attention to it. It might though have some merit for those comparing Aviva with other insurance shares.
Recently there was a change of CEO following the departure of Mr Andrew Moss. New management is commonly one way value is outed in companies, particularly large ones that have a lot of attention focused upon them. When performance continues to be poor or mediocre, something is normally done about it in the end. And that is why I was willing in this case to trade off my usual value indicators against the big-cap size of Aviva.
Unlike a lot of small investors I don't care about management generally and in most cases don't even know CEO names and similar stuff. Numbers talk louder than mere humans to me. But a change of management, as distinct from a knowledge of the personalities involved, can be the trigger for a re-rating of a value share though this is never certain. There certainly hasn't been any major re-rating of the share price so far for Aviva but there has been a fair amount of action by disposing of a number of assets and cost cutting etc.
If these actions turn out to be profitable, then that won't be seen in this year's figures but should start to show through from next year. The stock market though doesn't work like that and over the shorter term sentiment is usually the bigger driver of prices than the numbers. For a long time Aviva has been out of favour due in my view essentially to poor sentiment. The euromess in particular perhaps.
Thus a re-rating of the share price won't necessarily walk in step with re-rating of the company's profits. It will require a turnround in sentiment and that can happen at any time, short or long term. Value will eventually out one way or another and I still think this share has it. Meanwhile there's that unusually fat yield to smooth the wait.
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> Stephen owns shares in Aviva.