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I’d buy Aviva shares for their dividend

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UK insurer Aviva (LSE: AV) announced during today’s third-quarter update that it is resuming dividend payments to shareholders. Investors can interpret the fact that Aviva shares will pay a 7p interim 2020 dividend in January 2021, and expect to pay a final 2020 dividend of 14p, in several ways.

I could say that Aviva’s dividend has fallen by almost a third. That would be true when comparing the total expected 2020 dividend of 21p to 2018’s 30p dividend. But, if the base of the comparison is 2019’s total dividend of 15.50p, then Aviva’s 2020 dividend would be 35% higher year-on-year. It’s also worth pointing out that Aviva looked on track to pay a bigger 2019 dividend compared to 2018 before the coronavirus crisis rocked the world.

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Why did Aviva need to cut its dividend?

Being an insurer, Aviva collects revenues from premiums on the policies it writes, and from selling them to reinsurers. Aviva invests in a pool of assets, which it uses, in addition to ongoing premium payments, to meet insurance claims. The viability of the business depends on many assumptions, in particular, the average number and size of payouts. If those assumptions are wrong, then the asset pool and premiums coming in might not be enough to cover policyholder insurance claims.

The coronavirus crisis rendered any assumptions null and void given expectations of rising insurance claims and falling premiums. Aviva’s asset pool was expected to shrink as the stock markets crashed. An additional complication is that Aviva is subject to regulatory requirements for its liquidity and solvency position. Changes to the cash coming in and flowing out and the asset pool have the potential breach these requirements.

All this combined to make 2020 a perilous year for Aviva and it had to act. The dividend cut formed part of that response and was designed to keep cash within the business. Other ongoing initiatives include a refocusing of the portfolio towards the core markets of the UK, Ireland, and Canada. Several completed and planned divestments, totalling $2bn since August, form part of that initiative. Most of that cash will go towards reducing Aviva’s debt.

Aviva shares are a buy for me

Aviva’s management made it clear they recognise that shareholders in insurance companies like their dividends. The 7p interim dividend announced today, and the 14p expected to be announced in March next year, combine to give Aviva shares, priced around 320p, a forward dividend yield of 6.6%. That yield is above average for a FTSE 100 company.

Linking the dividend to performance in Aviva’s core markets has given management enough certainty to state that ordinary dividend growth should be in the 3%–7% per year range. Aviva has coped with the crisis better than expected. In addition to the cash from divestments, operating cash generation has been impressive.

I think Aviva’s dividend looks safe. What’s more, after paying down debt and getting regulatory ratios where it wants them, Aviva has earmarked excess cash for either share buybacks or special dividends. That probably won’t happen until at least 2022, but could appreciably boost the dividend yield. Investing is about looking forward and all things considered, I would buy Aviva shares for their dividend today.

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James J. McCombie has no position in any of the shares 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.

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