Life and general insurance company Aviva (LSE: AV) (NYSE: AV.US) continues to bang the drum about its turnaround plans, and hosted a Capital Markets Day on 9 July, designed to inform and enthuse institutional and other investors, and to entice them aboard the good ship AV Recovery.
What’s the plan, Mark?
According to Aviva’s CEO, Mark Wilson, the firm has a three-part strategy.
Part one is to pursue the competitive advantage that comes from being a composite insurer offering life, general and health insurance, and asset management. The firm reckons that in the modern world of digital marketing it is easier to amalgamate and package products for cross selling to customers from the different areas of its business.
Part two involves the total embrace of the digital world. The firm pledges to go ‘digital first’ across all its distribution channels.
Part three is a commitment to refocus the business on profitable geographic areas. World domination for the sake of it is off the agenda. The company says it has already reduced its footprint from 28 markets in 2011 to 17 today and improved its return on capital. The idea going forward is to focus on a small number of markets where the firm enjoys scale and profitability or a distinct competitive advantage.
Cash flow and growth
Growth doesn’t really hold much weight unless supported by cash flow, so it’s good to see Aviva focusing on its cash-generation performance. The firm aims to double its excess annual cash flow from £400m in 2013 to £800m by the end of 2016. To help with that, the company means to keep a keen eye on its outgoings and targets an operating expense ratio below 50% by the end of 2016 compared to 54% in 2013.
Debt management also features in Aviva’s turnaround plans and the firm aims to reduce the intercompany loan balance to £2.2 billion by the end of 2015 and to reduce its gross external leverage ratio to below 40% of tangible capital over what it calls the medium term.
The debt record looks like this:
| Year to December | 2009 | 2010 | 2011 | 2012 | 2013 |
| External borrowings (£m) | 15,000 | 14,949 | 8,450 | 8,179 | 7,819 |
As a financial company, Aviva operates in a cyclical industry and forward profits and cash flow will likely fluctuate with the ups and downs of the wider economy. With external borrowings running at about four times the level of operating profits, debt seems high, and Aviva will need to bear down on borrowings if it is to be in good shape when the next downturn comes.
What now?
Aviva’s CEO acknowledges the potential for challenges ahead but reckons the size of the opportunity for the firm is compelling. At a share price of 495p, Aviva’s forward dividend yield comes in at about 3.8% for 2015 and the forward P/E rating is around 9.6. City analysts reckon earnings will likely grow at 11% that year, so the valuation looks modest.
However, I’m mindful of the firm’s cyclicality, which demands an increasingly lower rating as the economic cycle matures, which could drag on investor total returns.