Aviva: a share for income investors to tuck away

Insurance giant Aviva is one of the highest yielding stocks in the FTSE 100 – and it’s cheap, too, making it a tempting target for income investors. Rupert Hargreaves delves into the numbers.

Insurance giant Aviva (LSE: AV) recently completed a 76 for 100 share consolidation as part of its plan to return £4.75bn to investors.  

The company decided to consolidate the number of its outstanding shares after distributing £3.75bn via a ‘B’ share scheme. Under the scheme shareholders have received one ‘B’ share for every ordinary share, and this special unit will be redeemed at £1 “before the end of May.” On top of this capital return, the firm has also bought back £1bn worth of shares.  

Underpressure from activist hedge fund Cevian, the largest fund of its kind in Europe, Aviva’s CEO Amanda Blanc is returning more cash to shareholders. She has promised to raise the company’s dividend to 31p per share this year, and 32.5p in 2023.  

Based on these numbers, the Aviva share price supports a post-consolidation forward dividend yield of 7.6%, making it one of the highest yielding stocks in the FTSE 100. That’s without including the firm’s recent special cash returns. The stock also looks relatively inexpensive. It is trading at a forward price/earnings (p/e) multiple of around 7.1.  

Still, there’s more to investing than just picking the stocks that look cheap. If it were that easy, we’d all be rich. It’s not enough to know that a stock is cheap, we need to understand why.  

The Aviva share price looks cheap, but is it really a bargain?  

Aviva is a complex business to understand. At its core, it is a life insurance and long-term savings (pensions) provider, but it also offers non-life insurance products, wealth management services and has a “closed book” of legacy policies.  

The company has been working to streamline its operations over the past few years, divesting £8bn of non-core operating units. Most of the proceeds have been returned to investors, although a chunk has also been used to reduce debt.  

While these asset sales have helped simplify the operation, Aviva remains a lumbering beast with mixed growth prospects. That seems to be why the market is in no rush to buy the stock. Yes, the company is returning a lot of cash to shareholders, but life and non-life insurance has always, and will continue to be, a slow and steady business.  

It’s also incredibly challenging to analyse how a life insurer and long-term savings provider will perform in the long run. Products sold today will be redeemed at some point in the future, and they require fastidious calculations to ensure a profit. Even a slight change in interest rates can have a big impact on these figures. 

Aviva is trying to break away from this template by growing its non-life insurance and wealth management arms. Non-life insurance or short-tail insurance has a much shorter (as the name suggests) lifespan. Policies are typically renewed every year, generating a more predictable and quicker income stream for the business. There’s also more scope to adjust prices quickly to reflect changing market conditions. 

This is a bright spot for the firm. In the first quarter of 2022 the group’s general insurance business reported its best sales in a decade as “people were attracted to the strength of the Aviva brand and the quality of our products.” General insurance sales rose 5% overall.  

Unfortunately, wealth management is proving to be a harder nut to crack. Overall sales were 3% down year-on-year with overall assets under management falling 1% to £150bn mainly due to market volatility. Assets under management at the group’s Aviva Investors fund management arm fell 5% to £253bn year-on-year.  

Management believes wealth management will be a key area of growth in the coming years as rising numbers of retirees search for better ways to invest their money. To that end Aviva has decided to acquire Succession Wealth for £385m.  

Aviva’s strong brand lends itself to this strategy; the cost of doing business for wealth managers is becoming prohibitive due to the regulatory burden and the rising price of liability insurance. With costs rising, many managers are pulling out of the market, but there’s a growing demand from customers for these services. This is where the firm can create value. It has the size and scale to deal with rising costs, and its brand is well trusted among savers.  

A dividend play with limited growth prospects 

In my view, the investment case for Aviva is all about the company’s dividend. Its portfolio of financial services generates a steady stream of cash, which management can return to investors.  

This also appears to be why Cevian decided to buy a large stake in the company last year. As well as calling for the insurer to return £5bn from asset sales, the fund also claimed that Aviva has headroom to hike its dividend payout to 45p per share within three years (pre-consolidation). While it has made progress towards this target, current plans still fall short.  

Still, further cost-cutting measures are planned, and at the end of the first quarter Aviva reported a pro forma solvency ratio of 192%. That’s a good deal above the 180% level at which it has said it would consider returning excess capital if there were no better case for reinvesting the cash.  

Aviva looks like a cash cow, but investors looking for growth rather than income might be disappointed. Like one of the company’s pension policies, there’s an attractive level of income on offer, although capital growth might be harder to come by.

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