Is Aviva a good investment?

Could Aviva (LSE: AV) be one of the best shares for an income-focused investor?

Potentially yes. The insurer and investment manager has been growing its dividend consistently year-on-year. The overall yield is also well above the FTSE 100 average. The shares are yielding over 7%, against an average of more like 4% for the FTSE 100 as a whole. The downside to the high yield is the low dividend cover, which based on last year’s numbers is only around 1.27.

Earnings clearly can’t fall too much before the dividend may have to be cut – but I feel it’s safe for a while as many FTSE 100 companies are currently operating with similar low dividend cover.

Change is in the air

Much of the news flow around Aviva has been around its strategy and leadership team. Investors certainly have to try and unpick what might be going on.

The retirement of Aviva chairman Sir Adrian Montague was announced only in January this year. He will step down as soon as a successor is in place and the process to find that person is already underway.

He took the role at Aviva back in 2015 so worked primarily with Mark Wilson – who himself left Aviva in 2018. Montague had originally joined the insurer as a non-executive director two years earlier.

The CEO who replaced Wilson was an Aviva insider, Maurice Tulloch. He joined the insurer in 1992. He was bought in to speed up the restructuring of the company which it was felt was proceeding too slowly. Aviva is moving forward with developing a new strategy to help it achieve a return on equity target of 12%.

Strategy

A breakup plan is rumoured to be the reason behind Sir Adrian Montague leaving Aviva. Some top directors are reported to have been left frustrated after radical plans for the FTSE 100 insurer to split itself in two were rejected by the board, who chose to keep the company intact.

Instead, it’s simplifying its business into five operating divisions and selling its stake in its Hong Kong unit to joint-venture partner Hillhouse Capital. The company added its in talks with partners on its Vietnam business and joint venture in Indonesia.

There had been speculation Aviva might sell its Singapore business but that hasn’t come to pass. It’ll also keep its joint-venture business in China.

Commenting Aviva said:

“Following a thorough review of options for the Singapore business, including seeking offers … Aviva has concluded that the best value for shareholders will be achieved by retaining the business.”

This is all needed because The City considers Aviva’s structure to be clunky. If it can become more streamlined its reputation amongst big investors will improve. And hopefully so to will its margins and profitability.

Results:

Half year results covering the first half of 2019 showed that operating profit rose just 1% to £1,448m. Operating EPS rose 2% to 27.3p. Group ROCE in HY19 was 9.6%. In HY18 it was 9.5% and in HY17 it was 9.3%, suggesting there has already been some improvement in improving the firm’s use of capital.

Maurice Tulloch, Chief Executive Officer, said: “Aviva has strong foundations to build upon but there is much to do to improve our performance. Our performance is mixed, with operating earnings per share up 2%. We have delivered strong general insurance results with a combined ratio of 95.9%. In life insurance and asset management, operating profits declined due to challenging market conditions and the absence of a longevity reserve release.”

The group admitted there were challenges during the first half. It was adversely affected by market conditions affecting its savings and asset management division. It also encountered intense competition in individual protection and personal lines general insurance where it chose to maintain prices and margins rather than lower prices and chase higher volumes.

Commenting on its outlook the company said:

“The challenging macro backdrop, particularly very low government bond yields, is expected to persist in the second half with ongoing uncertainty in the political environment and a softer outlook for economic growth in Europe and the UK. Despite this, our first half results have demonstrated that Aviva is growing its customer franchise in targeted product lines and maintaining discipline on pricing and operating margins. Looking forward we need to take decisive action on strategy, efficiency, and capital allocation as we seek to improve OCG, meet our cash flow targets, reduce operating expenses ,lower debt leverage and ultimately capture the long-term opportunities in each of our markets.”

Full year results come out 5 March 2020. It’ll be key to see whether progress has been made at all, especially in light of Tulloch’s predecessor being given the boot for being too slow to implement change. At HSBC, the previous CEO, John Flint, was kicked out for not moving quickly enough, so expect to see change.

SWOT analysis of Aviva

Strengths

  • Has a strong brand
  • Has a global presence, including in China and fast growing Asian markets
  • Strong capital position and balance sheet

 

Weaknesses

  • Bloated corporate structure makes Aviva slow and cumbersome
  • The business has been struggling in Canadian market
  • Its biggest division, life business, has seen operating profit fall. Same for its fund management division.
Opportunities

  •  Strategy could simplify the group and improve ROCE and margins
  • Digitalisation provides opportunities to improve customer service, attract customers and cut costs
Threats

  • Potential internal disputes over the direction and strategy of the group
  • Losing a respected chairman

 


Quick comparison to Legal & General

Compared to Legal & General (L&G) (LSE: LGEN) – one of the most similar businesses on the FTSE 100 to Aviva, the latter is both cheaper and high yielding. However, I think L&G (which I admit I own shares in) has a lot more potential. Not long after Aviva’s results, L&G reported operating profits from divisions of £1.2bn during the first half, up 12% year-on-year, driven by a very strong result from the annuities business – both at an institutional and individual level. Although beyond annuities, results generally came in below market expectations.

Its focus on retirement is really paying off. Legal & General Retirement (LGR) reported 36.5% growth in operating profits to £655m.

The strong LGR result reflects 45.2% growth in Institutional retirement profits, to £524m, following the completion of bulk annuity deals worth £6.7bn during the half. That included the largest ever UK bulk annuity deal, completed with Rolls-Royce and worth £4.6bn. The division continues to expand, with its first Canadian transaction completed during the half, and further deals completed in the US.

At L&G, insurance performed less well. Operating profits fell 13% to £134m, following one-off model changes last year. However, underlying profits rose 8%, with good premium growth.

Final thoughts

I think both L&G and Aviva are great income investments, both providing yields in excess of 5%. L&G with its focus on retirement has the better current strategy and execution and a more stable management. The quality of the business should keep driving its share price on.

But for investors willing to take a bit more risk, Aviva has a lot of opportunity to improve and it has a higher dividend yield. It’s a very close thing but Aviva is I believe right up there as one of the best FTSE 100 shares to own. Especially for those investors who are looking for income as a primary goal.

Please note I own shares in Legal & General.

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