Successful investors use a disciplined approach to picking stocks, and checklists can be a great way to make sure you’ve covered all the bases.
In this series I’m subjecting companies to scrutiny under five headings: prospects, performance, management, safety and valuation.How does Aviva (LSE: AV) (NYSE: AV.US) measure up?
1. Prospects
Aviva is the only UK composite insurer. Life business contributes two thirds of operating profit. Half of new business comes from the UK, with Europe contributing 40% and South East Asia 10%.
Life firms such as Legal & General and Standard Life are shifting towards an asset-light business model, but Aviva is significantly dependent on investment returns.
The UK general insurance market is overcrowded and competitive, with premiums subject to the insurance cycle.
Aviva’s strong brands and franchise have been squandered. New management is implementing a turnaround plan to strip out costs and bureaucracy, reduce gearing and bolster capital, and focus on higher margin businesses. The US business is being sold to realise £1.6bn cash.
2. Performance
Aviva has found revenue growth elusive, and profits have been erratic. That has led to several dividend cuts since the late 1990s, most recently last March.
The latest half-year results indicate the turnaround plan may be starting to work, with expenses down and cash flow up.
3. Management
After the ousting of former CEO Andrew Moss, chairman John McFarlane inaugurated the turnaround plan and made significant strides in selling off businesses.
The new highly regarded CEO, Mark Wilson, has carried on implementation with the added bite of the dividend cut and recruitment of some ruthless top brass.
4. Safety
Aviva has relatively high gearing for the sector, with debt-to-tangible equity of 50%. It’s targeting a reduction to 40% in part from the proceeds of the US sale. Exposure to Europe and dependence on investment returns also add to risk.
The US sale will boost the capital surplus to within its target range. However, Aviva has recently been identified as one of nine insurers that are ‘Global Systemically Important Financial Institutions’. Apart from being required to maintain a ‘living will’, that’s expected to increase the required capital surplus.
5. Valuation
Aviva shares are trading at a discount of 25%-30% compared to Prudential, Legal & General and Standard Life, based on its prospective P/E of 10. They are also at a discount of around 10% to the MCEV net asset value, the measure preferred by the actuarial profession.
Rebased, the dividend yield is 3.8%, lower than Legal & General and Standard Life.
Conclusion
Whether Aviva is a value play or a value trap depends on the success of its turnaround plan, which the CEO acknowledges will be a long haul. Early signs are encouraging, but exposure to the eurozone and financial markets generally means the shares are not without risk.
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> Tony owns shares in Aviva and Prudential but no other shares mentioned in this article.