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Are Aviva plc And Prudential plc Risky Bets For 2015?

The most obvious question for value hunters in the insurance sector is whether Aviva (LSE: AV) (NYSE: AV.US) is a steal right now. Well, I reckon its shares are fairly attractive, although they are not a bargain. Another question is whether Prudential (LSE: PRU) will react to Aviva’s latest acquisition of Friends Life; I wouldn’t bet such an outcome, but Prudential could be a decent investment on its own.

Given the uncertain surrounding the regulatory environment, it takes courage to bet on both Aviva and Prudential, I appreciate that, but at 480p/500p a share the Aviva investment could easily deliver a 15% pre-tax return, excluding dividends, in 2015. Prudential, meanwhile, could do even better if recent trends are confirmed. 

Aviva: Too Risky For You?

Aviva is merging with Friends Life in a multi-billion deal that could boost shareholder value, although the market doesn’t believe the tie-up is in the best interest of Aviva shareholders. Aviva has been under pressure ever since the deal was announced in late November (-10% over the period), but short-term weakness in its stock price doesn’t change the investment case over the medium term, in my view.

As I recently argued, assuming a very aggressive scenario for cost synergies, the combined entity’s operating profitability will rise significantly, which will benefit cash flows and Aviva’s dividend policy. Aviva expects about £600m of incremental cash flow from the tie-up and it also expects to retain its coveted credit rating. 

Investment and financing opportunities are few and far between, so defensive M&A could be the path to follow in the insurance sector. The shares trade about 15% below the average price target from brokers, as the recent Friends Life deal caught investors and analysts off guard. 

Will Prudential Take Heed? 

Prudential is a less risky bet than Aviva. It has delivered plenty of value in the last couple of years: its stock performance reads +62% over the period. Prudential doesn’t need M&A, in my view. 

The average price target from brokers has risen by 14% in the last 12 months and, at about 1,620p a share, is still 9% above Prudential’s current stock price. Prudential could surprise investors in the next few quarters, of course.

Based on trading multiples, one may argue that Prudential stock looks fairly valued, but earnings and dividends should rise nicely in the next 12 months or so. Its valuation should continue to benefit from its geographical mix and growth prospects in Asia, a decent dividend yield as well as better returns than rivals. What’s not to like about it? 

Well, a bottom-down approach in the sector suggests caution.

Elsewhere, I don’t fancy any other players in the sector, and I appreciate you may be looking for value elsewhere, just like me!

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Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.