Insurance stocks have been a tough sell over the last year. Brexit, low interest rates and the risk of regulatory change have all helped to keep this sector out of favour.
But the reality is that most of the big Footsie insurance stocks appear to be doing well. This year’s sell-off has left some very generous dividend yields on the table. I believe this sector offers some attractive buying opportunities.
Retiring profitably
Many of today’s retirees have the kind of final salary pensions younger workers can only dream of. So it’s not entirely surprising that a business like Saga (LSE: SAGA), which provides services for the over 50s, is doing well.
Today’s interim results show that earnings from continuing operations rose by 8.2% to 7.9p during the six months to 31 July. Pre-tax profit was 8.5% higher at £109.9m, while the group’s interim dividend was lifted by 22.7% to 2.7p.
One concern with Saga was that it was quite heavily indebted when it floated in 2014. However, the group’s cash generation has been good and net debt has fallen from £1,737m in January 2014 to £534m at the end of July. This has brought Saga’s net debt/EBITDA ratio down to 2.2 times, just above its target range of 1.5-to-2-times.
Given the speed at which the group’s debt has fallen, I’m no longer concerned by this. Indeed, I’d argue that Saga’s ability to generate free cash flow suggests that strong dividend growth is likely as debt continues to fall.
Saga’s share price has edged higher following this morning’s results. The group expects pre-tax profit to rise by between 5% and 7% this year. That seems to be broadly in line with current consensus forecasts, which suggest that post-tax earnings will rise by 3.2% to 13.9p.
Saga shares trade on 16 times 2016/17 forecast earnings and offer a prospective yield of 3.8%. With good cash generation and further growth likely, I believe the stock remains a buy.
Cheap as chips
Despite this positive outlook, Saga stock is no longer an obvious bargain. You may also be unsure about holding shares in a company that combines insurance with a much less profitable travel business, as Saga does.
One possible alternative is Aviva (LSE: AV). After hitting a 52-week high of 522p at the end of last year, Aviva shares plunged to a low of 290p after the EU referendum. They’ve since recovered to 448p, but still look good value to me.
Aviva reported strong growth in new business during the first half, with life insurance and general insurance premiums up by 7%. Cash remittances rose by 52% to £725m, thanks partly to the integration of the Friends Life business. This acquisition is on track to deliver the promised £225m of cost savings by the end of this year, one year ahead of schedule.
On the basis of the firm’s first-half results, this year’s forecast dividend of 22.6p should be comfortably covered by surplus cash this year. Earnings are expected to rise by a further 7% in 2017, which will hopefully provide support for further dividend growth.
With a forecast P/E of 9 and a prospective yield of 5.2%, I continue to rate Aviva as an income buy.
