Warren Buffett probably wouldn’t be where he is today if he hadn’t invested in insurance. That’s not just my view. In 2004, Mr Buffett wrote that his firm, Berkshire Hathaway, “would be lucky to be worth half of what it is today” without 1967’s acquisition of US insurer National Indemnity for $8.6m.
Mr Buffett has also acquired several larger insurance businesses over the years, including US firm Geico, a major motor insurer.
Geico is perhaps the closest of Buffett’s businesses to the UK stock I want to consider today, FTSE 100 insurer Aviva (LSE: AV). The two firms aren’t a direct match — Aviva has a broader spread of activities and geographic coverage. But the Aviva business would certainly be familiar to Mr Buffett.
The market hates Aviva
Mr Buffett likes insurance companies because they provide him with a large float of customer cash that can be invested elsewhere, until it’s needed for claims payouts. With good underwriting, some of this cash will be surplus each year and available for distribution to the company’s owners.
Aviva offers shareholders some of the same benefits. In 2018, its operating businesses returned £3,137m of cash to the parent company. In 2017, the figure was £2,398m. This cash has been used for dividends, debt reduction and share buybacks.
For example, last year the firm returned about £1.2bn to shareholders through dividends alone. This represents a trailing yield of about 8.7% on the current share price. Given that this payout looked affordable, you might expect such a generous income to attract new investors.
That’s not happened. Although the company is expected to make a similar dividend payment this year, the Aviva share price has fallen by more than 25% over the last year. Investors don’t like Aviva.
Is this a buying opportunity?
Aviva shares currently offer a forecast dividend yield of 8.8% for the current year. But yields this high are often a warning of possible problems.
Before rushing out to load up with Aviva stock, we should consider what might be wrong at this firm, which was created when Norwich Union merged with CGU in May 2000.
As a shareholder, I remain bullish. But I can see some potential problems.
Aviva is struggling for growth, and has been for some time. In 2018, operating profit rose by just 2%. In 2017, the figure was also 2%.
This group doesn’t have the clear identity and growth focus of some rivals. For example, Prudential has a large, fast-growing business in Asia. Aviva operates in Asia, but it’s much smaller.
Similarly, Legal and General has delivered years of sustained growth thanks to its bulk annuity and asset management businesses. Aviva does similar things, but doesn’t have the same market share.
Aviva is left as a diversified general insurer, operating in markets that are fairly mature and slow growing.
Things may be about to change
New boss Maurice Tulloch is determined to fix these problems. He’s announced a review of Aviva’s Asian business which could lead to a sale. And he’s simplifying the UK firm’s structure to try and stimulate growth.
It’s too soon to say whether Mr Tulloch will succeed. But the shares currently trade below their net asset value of 432p and the group’s cash generation remains strong. I think there’s value here. If Aviva was a US firm, I reckon Mr Buffett might be interested.