Is Aviva’s 7% dividend yield safe?

The FTSE 100’s Aviva (LSE: AV) makes its money from life and general insurance along with asset management products and services. And in last month’s full-year report, chairman Sir Adrian Montague said the company had a year of “steady progress” in 2018 growing its profits and cash remittances.

Big debts and a rising dividend

The solvency cover ratio increased to 204%, and I know that if any firm talks about its solvency ratios, it’s a safe bet you’ll find bucket-loads of debt on the balance sheet. I tend to lump Aviva into a pile with the London-listed banks and label the whole lot as being in the debt-laden ‘wider financial sector’.

However, the directors pushed up the full-year dividend by 9% to extend a long period of dividend-raising as you can see from this table:

The dividend has risen by 100% over the past five years even though earnings have been erratic. You could take that as a sign that the firm could make a decent dividend-led investment from where we are now, but dividends don’t tell the whole story.

Along with erratic earnings we’ve seen a volatile share price over the past few years with big swings up and down and a broad multi-year lurch sideways. I think that makes the share a bit of a moving target for dividend-hunting investors. Time a share purchase poorly, and a down-swing in the stock could wipe out years’ worth of your dividend gains. I reckon that’s the main problem with trying to use essentially cyclical firms such as Aviva for the purpose of dividend investing.

Focused on debt-reduction

But right now, the tone is optimistic. Montague said in the report that earnings growth has been achieved by means of higher profits from the company’s major businesses, from the programme of ordinary share buy-backs, from debt-reduction and from “a higher net contribution from longevity and assumption changes.”

You can see from the following table that borrowings remain high and the operating cash flow is a bit bumpy, as I’d expect from a cyclical firm. I’m glad to learn that the firm plans to tackle its debt load. If cyclical firms don’t pay down their borrowings when the economic sun is shining they could be in trouble when we see the next major economic slump.

Looking forward, Aviva aims to reduce debt by “at least £1.5bn by the end of 2022,” Montague said. You can get a feel for what a difference it will make to the firm’s ability to pay shareholder dividends by the statistic that the reduction in borrowings will save the firm around £90m per year in interest expenses.

Montague asserted that “the security and sustainability of our dividend remain paramount,” but the future growth of the payment will depend on “business performance and growth prospects.” However, because the cyclical aspect is out of the directors’ hands, I’m not keen on Aviva as a dividend candidate.