Aviva (LSE: AV) shares currently support a shareholder yield of 12%. This is one of the highest returns in the FTSE 100, and it looks as if it is only set to grow in the years ahead. Below I’m going to take a look at whether or not this income champion deserves a place in your portfolio.
Earlier this year, Aviva’s management to set out its plans to reward shareholders following years of business restructuring. After cutting costs and exiting non-core markets, it is now better positioned than it has ever been to grow and reward investors.
As part of the strategy, the firm announced that it is planning £2bn of excess capital (capital that isn’t needed in the business) throughout 2018 and 2019. Just under £1bn will be used for debt reduction. £500m has been earmarked for bolt-on acquisitions, and a total of £600m is going to be spent buying back stock.
The company hasn’t hesitated in deploying this £2bn windfall for investors. First-half results, issued earlier today, informed investors that the business has already started its buyback programme and has paid back €500m of expensive debt.
Unfortunately, the release also revealed a 2% decline in operating profit. Management has blamed business disposals for the fall in profit and expects the group to return to growth during the second half of the year. Overall, the group believes it is on track to grow profits by 5% for the full year. Operating EPS came in at 26.8p, beating City forecasts of 25.1p.
What really attracts me to this business is its dividend outlook. Today’s release revealed a 10% increase in the interim dividend to 9.3p, putting the company on track to achieve its fourth year of double-digit dividend growth in a row. Analysts are expecting a similar level of growth for the final distribution as well. Current numbers suggest an increase of 9.7% for Aviva’s full-year payout to investors, giving a total distribution for the year of 30.1p, which is equivalent to a dividend yield of 6.1%. But as noted above, this isn’t the only capital the company is returning to shareholders.
Shareholder yield captures the three ways of returning company cash to investors: debt paydown, share buybacks, and dividends. All of these are inherently capital returns because they all increase shareholder value, albeit in different ways. Paying down debt, for example, transfers wealth from creditors to shareholders. Buybacks reduce the number of shares outstanding, increasing the value of each share that remains.
Including the £900m of debt paydown, £600m share buyback and 30.1p full-year dividend, I estimate Aviva’s total shareholder yield will top 12% for 2018.
Turning to valuation, Aviva looks to me to be undervalued. Based on current City estimates for growth, the stock is trading at a forward P/E ratio 8.5, a discount of nearly 30% to the rest of the insurance industry. With the company expecting mid-single-digit earnings growth for the foreseeable future, I see no reason why it deserves such a deep discount the rest of the industry. I believe this is a desirable price to pay for a high-quality insurance business with a 12% shareholder yield.
Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.