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.
| Company | Market Cap | P/E | Div Yield |
|---|
| Aviva | £7.9bn | 5.0 | 9.2% |
| Legal & General (LSE: LGEN) | £5.4bn | 6.5 | 5.2% |
| Prudential (LSE: PRU) | £13.9bn | 8.8 | 4.4% |
| Standard Life (LSE: SL) | £4.5bn | 10.6 | 6.7% |
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.
