Should I Buy Aviva?

Published in Company Comment on 2 October 2012

Harvey Jones weighs up Aviva (LSE: AV.).

It's time to go shopping for shares again, but where to start? Insurance titan Prudential (LSE: PRU)? Rain-soaked retailer Kingfisher (LSE: KGF)? Or dial-a-dividend behemoth Vodafone (LSE: VOD)?

There are plenty of great stocks to choose from, and I'm enjoying doing some window shopping. So here's the question I'm asking right now. Should I buy Aviva (LSE: AV) (NYSE: AV.US)?

The joy of 8.1

Insurer Aviva has a cult following on the Fool, and with good reason. It's a big, solid company whose share price has been badly knocked by the eurozone crisis, and looks ripe for a re-rating.

Aviva's shareholders have had to be patient, because aside from the odd flicker, this sleeping behemoth has yet to spark back into life. I've been holding it for a couple of years without pocketing a penny in capital growth, but I'm not complaining, because I'm being paid very nicely to sit on my hands.

Aviva yields a mighty 8.1%, the third highest in the FTSE 100. I've got money in a savings account earning just 2%, and nobody is going to re-rate that. Should I use it to buy more Aviva?

Viva Aviva

Aviva does 60% of its business in Europe, but it can't blame all of its woes on the stricken continent. The 10% drop in its operating profits in the first half of 2012 was largely down to a £876 million write-down in its US business, the sale of RAC, £40m of UK weather-related claims and adverse foreign exchange movements.

All that knocked the joie de vivre out of Aviva, which made a net loss of £681 million after tax, compared with a £465 million profit 12 months earlier.

The road to Rome

Chairman John McFarlane's predecessor, Andrew Moss, was hounded out by disgruntled shareholders in May, and McFarlane has been busily managing expectations by warning the second half of the year won't be much better. The good news is that Aviva held its fat dividend at 10p a share.

Aviva's share price shot up 15% to £3.63p over the following month, only to dip recently. There seems to be a pattern here. When there's hope of a eurozone bailout, the stock rises, but when protesters burn barricades in Athens and Madrid, it falls.

Patience is a virtue

I'm writing this on 1 October, the day auto-enrolment begins, which will give millions of British workers access to a workplace pension for the first time. That should be a great opportunity for Aviva.

On the downside, the insurer faces expensive restructuring costs, and Europe is going to get worse before it gets better. Aviva still holds €5 billion worth of Italian sovereign bonds. I thought you should know that.

Still, there's always that dividend. True, it is only covered 0.7 times, and may be raided to help boost Aviva's capital reserves, but just look at the size of it. Trading on a forecast price-to-earnings ratio of just 6.1 for December 2013, Aviva still looks a buy to me, especially on any further weakness. Just prepare to be patient.

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> Harvey owns shares in Aviva, Prudential and Vodafone. He doesn't own shares in any other company mentioned in this article. The Motley Fool has recommended shares in Vodafone.

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lameuse 02 Oct 2012 , 1:04pm

I'm happy to retain AVIVA in my high yield portfolio

LastChip 02 Oct 2012 , 2:39pm

Let common sense prevail.

How long do you think Aviva can continue to post losses and maintain that dividend?

It's had a dividend cover of less than one for some time now. Something has got to give!

Whatever way you cut it, it's lost 216m over two years. You don't need a maths degree to work out that's over 2m a week. All it needs is for some natural disaster to hit it further this winter and what do you anticipate happening then?

I don't share your enthusiasm for the shares, but then I rarely follow the herd. However, I might be tempted if I saw signs of a definite turn around. Time will tell.

I'd rather enter at a point with less risk on the table than right now, even if it means a more subdued return.

ANuvver 02 Oct 2012 , 3:14pm

Just to clarify, 10p is the interim, payable on 16 Nov (the share is already ex-div). The last final was 16p, paid on 17 May.

As I write, that makes the historic yield 7.91%.

There is no conclusive trend to indicate dividend growth over the past 5 years - payouts have been somewhat quixotic. Certainly, they've held the interim at last year's level, but if anything a future freeze or cut looks the likeliest outcome. Always remember, there are two ways a share can rerate.

As far as I'm aware, there is no statement of forward policy regarding dividend payouts. Anyone know any different?

To my way of thinking, AV's price is shackled to sentiment on the eurozone. Not necessarily a bad thing - we are often advised these days that Europe looks cheap. But that's largely why such a huge cash generative business has an unusually volatile SP.

I'm a holder, but I would suggest that a potential buyer bide their time until the next euro jolt hits and drives the price down. Spain capitulating on a bailout will do it, but that possibility is perhaps mostly priced in. You might do worse than to watch for increasing speculation that French bonds are in trouble...

Oh, hang on. I'm a holder. Scratch all that - everybody buy it, now! Free rainbows, ponies and yachts!

duffmanchon 02 Oct 2012 , 4:19pm

If the dividend cover is less than one they are borrowing to pay it no?! Doesn't sound very sustainable. I got burned on Aviva last year, classic value trap. No discernable moat and rubbish management. Steer clear.

goodlifer 03 Oct 2012 , 7:52pm

"It's had a dividend cover of less than one for some time now."

Are you sure?
If digitallook is to be believed, 2012's divvy's covered just over 1.9 times.

Or am I just a sucker for creative accounting?

LastChip 03 Oct 2012 , 8:32pm

goodlifer, from the information I have as of today, the cover is 0.22. Also, for the year ending 2011, the available funds for a dividend were, 225m, but they paid out 431m. Hence my worry that something has to give.

I'm not sure where the disconnect is between our two figures, except yours may be more up to date. My concern is, how can digital look come up with a figure for 2012, when the year isn't complete? Unless they're basing that information on the interim dividend only (and that's just a guess).

I'm the first to admit I don't delve deeply into figures - life's too short! But if what I can easily see doesn't add up, then I stay away.

jaizan 03 Oct 2012 , 9:40pm

After using Digital Look or equivalents to screen stocks, it's always advisable to check actual company figures before buying the stock.

goodlifer 04 Oct 2012 , 8:35am

"After using Digital Look or equivalents to screen stocks, it's always advisable to check actual company figures before buying the stock"

Sounds like sense.
And what do they say?.

fsaccountant 04 Oct 2012 , 10:31pm

Hello All,

Just to delve into those accounts for you a bit. I am rather suprised and perhaps a little concerned that "life's too short" to delve deeply into the figures... your money on the line!!

If you base the dividend cover on IFRS EPS then yes the cover is far too low and less than 1, suggesting it to be unsustainable. However if you care to assess their income statement the reason for such a low EPS figure (and hence div cover) is primarily due to large goodwill writedowns (known as an impairment).

For those of you unaware, goodwill is an intangible held on a company’s balance sheet when it acquires another company. When a company purchases another there is often a difference between the target company’s book value and the amount which the takeover company pays. e.g £100m purchase price of a company with only £50m of assets. This clearly leads to a difference of £50m which has to be accounted for when the company which has been purchased is accounted for in their new parent’s books. This difference (the £50m) is held as "Goodwill" on the balance sheet. This is an intangible and has no physical presence. Companies are required to assess these intangible "assets" for impairments - this normally happens when a company’s brand image has been harmed (e.g. as a result of bad press). The process of impairing goodwill has no cash flow impact at all, it is only an accounting treatment (i.e whilst it will reduce the amount goodwill is held on the balance sheet at, it will have no actual effect on the cash from which dividends are paid. Please remember dividends are not paid out of accounting profit, they are paid out of cash).

Now to apply this to Aviva's results:

In the year to 31 Dec 2011 Aviva took goodwill impairment charges of £392m on its continuing operations (significantly larger than years before). The profit generated from continuing operations was £584m, hence excluding this accounting charge, profit from continuing operations is increased to £976m (significantly more healthy). If we further strip out the accounting loss of "amortisation and impairment of intangibles", £171m, this further pushes profit up to £1,147m. Please note this is a simplified explanation of their movement in profits, and only looks at continuing operations (for obvious reasons - you do not invest in a company for its non-continuing operations!), but it is important to note that these "losses" do not effect Aviva's ability to pay out a dividend in the way they effect its EPS - and are accounting treatments. Hence if you look at the EPS for the continuing operations for the year it is given to be 17p (basic). This would give the Div cover as (26p/17p) 0.65.
However if you strip out the accounting treatments described above, profits would approx double - leading to a very different dividend cover picture. (There are other impacts such as tax but these are relatively minor)

(Please note this is simplified and there are more "non-cash" items which could be stripped out).

In the half-year to 30 June 2012 Aviva took goodwill impairment charges of £876m on its US business. It also undertook "Impairment of goodwill, associates and JVs" of £603m and "Amortisation and impairment of intangibles" of £164m. Combined this is £1,643m worth of impairments. All of these "non-cash" accounting treatments have to be recognised as a loss in the firms profit figures; unsurprisingly Aviva reported a loss for the half year of £681m! I would suggest stripping out these non-cash "losses" before arriving at a EPS figure.

(Again Please note this is simplified and there are more "non-cash" items which could be stripped out).

For those wondering what impact this has. The write downs will reduce the amount of goodwill and intangibles held on Aviva's balance sheet and hence will reduce the NAV.

When trying to ascertain whether or not a company can afford to pay its dividend it is, in my opinion, very important to strip out such accounting treatments and to focus on the cash which the company is generating. It is also important to look at the continuing operations of a company, both for its EPS figure & cash flow movements.

A brief comment on the cash flow movements of Aviva. By the very nature of its business Aviva is highly cash generative. It has a large amount of cash held on its balance sheet (although note the majority is required to be held incase insurance claims have to be paid out against) and continues to produce cash. 2011 was not a good year for its cash flow, but looking at the half year 2012 results (and indeed going back over a decade of its financial statements, the overall cash generation is very positive) this has improved remarkably, and IMO returned to "normal" levels.

Unfortunately there are far too many accounting treatments and adjustments which are made to the financial statements of a company the size of Aviva's, to discuss them here. However, I hope this has given you some insight into the accounting treatments which can affect "accounting" profit, which does not equate to "cash" profit. As you can see Aviva has undertaken significant "accounting" losses due to goodwill impairments, which in years prior to the financial crisis it did not need to take.

Please note this is not in any way investment advice. There are many more factors to be considered than those which I have discussed here. Please always do your own research. I cannot promise you that the figures above are correct, but have to the best of my ability (and accounting knowledge been taken from Aviva’s financial statements). All opinions expressed here are my own. I do own Aviva shares.

Best of luck to all.

Especially those who "dont delve deeply into figures - lifes too short!"

LastChip 05 Oct 2012 , 12:16am

Thank you fsaccountant for your significant effort to educate us on some of the intricacies of company accounting.

You've probably discovered already, I don't tend to have a "conventional" style of investing and hence my comment about "life being too short".

Clearly you have a significantly greater knowledge than me when it comes to accounts and I have no problem with that and indeed envy you to some degree. But I'm a firm believer in the "random walk" theory and as such, accounts to me (other than when they are blatantly poor) have little weighting when I evaluate whether or not to invest in a company. What I look for is large debt, which in my world immediately rules them out and I don't like high gearing, which I suppose one could ague is a relative of debt.

Was it Neil Woodford that said, "I only have to be right more than 50% of the time"? And I achieve that comfortably, even though the accounts are only subjected to a cursory glance.

Without question, another of my more controversial heroes is Robbie Burns - The Naked Trader. He too has been pretty successful and doesn't delve very deeply either. So while I bow to your knowledge, as always, there's aways more than one way to skin a cat.

Like Robbie, if I don't know within 15 minutes whether a company is worth investing in, I drop it. Sure I loose a few, but so does everyone else.

But for all that, a genuine thank you for your post.

irfan12 29 Mar 2013 , 10:41am

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