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 Aviva Plc Full Year Update – 02 April 2015   

 

Company Overview

Aviva Plc is an insurance group headquartered in the UK. The group’s core service offering is centred on life insurance and general insurance products. The life insurance business accounts for nearly 70% of group income, while the general insurance offering sees the group provide everyday insurance cover for homes, health and motors to its 30 million-plus customer base.

Officially, the group operates under four geographical segments – UK, Europe, North America and Asia Pacific. Under each segment, Aviva offers its life insurance and general insurance products through a complicated structure of divided and separate subsidiaries.

Index FTSE 100 Ticker AV.L Latest Close 552.5
52 Week High 578.68 52 Week Low 458.20 P/E (F) 11.7
Dividend Yield % 3.2 Dividend Cover 2.7 CEO: Mark Wilson
CFO: Tom Stoddard  Previous Price Target   480.00  Current Price Target   480.00

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A strong start to the year for Aviva shares; price target hit

At the time of our last update we opted to hold our price target for Aviva at 480.00 pence in anticipation that the shares would average this level over the near term. Subsequently, the shares spent much of the six weeks between early December and mid January range bound between 460.00 pence and 500.00 pence.

The key event overhanging Aviva throughout this period has been the prospect of a merger with Friends Life going ahead, as any acquisition always presents significant risks to the acquirer over the medium term.

In addition to the prospective takeover, investors have been keenly awaiting the group’s financial results for 2014, which were released in March.

Now with a clear view of full year performance and taking into account the March 26 vote from shareholders in relation to the Friends Life merger, we write today to update our outlook for Aviva Plc and the shares.

Aviva Plc Share Price / Daily Intervals   

AVIVAAPRIL

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Aviva / Friends Life merger update and comment

March 2015 saw Aviva receive the go ahead from both regulators as well as all shareholders party to the potential tie up between the group and Friends Life. With these approvals in place there now remains no significant hurdle to the merger going ahead.

Many of our members will recall that our own view of the proposed deal at the time of its announcement was that, although there would be risks to a successful integration, the proposed purchase of friends life would add value for Aviva shareholders over the longer term.

We also noted that such a tie up would be in conformity with management’s strategic objectives to focus on generating both cash flow and growth for Aviva shareholders.  

Since this time little has changed to alter our view although we note, much of the analyst community remains sceptical of whether or not the deal is a good idea for Aviva at this stage.

The overwhelming number of concerns are centred around whether or not, at a time when the Aviva group itself is undergoing considerable change, an acquisition that entails a high level of integration risk will be viable for management.

In addition to integration risks some analysts have pointed out that the proposed level of “synergies” and savings (£225) is a best case scenario outcome, that must be achieved if the merger is to provide any form of added value.

In this regard we note that these these concerns are perfectly valid and that the above referenced risks cannot be ignored. Furthermore, they will likely constitute a significant source of uncertainty for the shares over the near to medium term.

However, we still believe that is is more likely than not that over the longer term, the deal will prove a success. In support of this view we note the continued success of Aviva’s management, particularly since acquisition of the relatively new chief executive Mark Wilson, in their attempts to restructure and turn around the existing business.

 

 

Aviva full year results overview

The group received a considerable boost to earnings in 2014 as investment income nearly doubled to £21.8 billion. However, expenses also increased by £7.6 billion during the year so all of the benefit from the increase in investment income never actually made it through to the bottom line.

Due to one off gains made on the disposal of assets during the 2013 period and their subsequent effect upon the bottom line, earnings at Aviva were actually lower in 2014 than in the previous year (2014 EPS: 49.6 pence, 2013 EPS: 65.5 pence).

Nevertheless, if one off income streams are stripped out of the 2013 result, post tax earnings at Aviva increased by 90% for the period; which provides some indication that the group turnaround plan is actually working.

As a result of the 2014 turnaround in investment income, group profits are now close to their post financial crisis high, which is a noteworthy event for those shareholders who have stayed the course throughout recent years.

Despite this, we caution that the road ahead for the group remains far from certain from an earnings perspective, most notably due to the contribution to earnings of the group investment performance which we attribute to a particularly strong performance from bond markets during the period.

A repeat of last year’s investment result is far from guaranteed in 2015, even unlikely in our view, as the group’s focus upon longer duration assets mean it could be hit hard in the event of a 2015 interest rate increase from the Federal Reserve and/or the Bank of England.  

 

 

Balance sheet, dividend and valuation

In relation to the balance sheet, Aviva’s merger with Friends Life should be a positive event as the combined group will benefit from a stronger capital position in addition to greater cash flows.

This is particularly positive in light of the looming implementation date (January 2016) for the European Union’s Solvency II regime.

It is also worthy of note that Aviva’s own debt profile has also improved marginally during 2014 although, in the near term at least, we expect that risks surrounding the merger will overshadow any other balance sheet positive events.  

In terms of the dividend, the group increased its total payout for the year by just over 20%, with much of the improvement being loaded onto the final dividend (12.25 pence) proposed at the end of the year. This left total dividends per share standing at 18.10 pence for the 2014 year, with this amount covered 2.7 X over by earnings for the period.

From a valuation perspective we see Aviva as close to being fairly valued at present given the risks which are likely to accompany the eventual merger with Friends Life.

While the group currently trades on a multiple of 11.7 X forward earnings expectations, which represents a considerable discount to the 24.1X life insurance insurance industry and the 16.4X insurance sector as a whole, such a crude comparison overlooks the fact that the dividend yield is less than half that available elsewhere across the sector.

For this reason we are comfortable with the current valuation and see no considerable upside or downside to the present level over the near term.

However, as time elapses and more information becomes available regarding progress with integration and the prospects for dividend growth at the combined entity, it is possible that support could emerge for an upgrade here.

 

 

A brief summary and conclusion

On the whole, both Aviva and its shares have performed strongly throughout much of 2014 and into the current year. However, we believe that if the group is to generate meaningful returns for shareholders over and above what has been seen during the recent period then this would only be likely to occur over the longer term.

In the intervening period there are a number of headwinds in play which will continue to challenge Aviva, not least of all the execution risks that surround its merger with Friends Life, which are themselves set against a backdrop of major change and transformation within the existing business.

Although from an earnings perspective the group without doubt demonstrated a stand-out performance for 2014, much of this was the result of a stronger investment performance, which we attribute to a similarly strong performance from bond markets.

It is far from certain that this investment performance will hold over the coming period, even unlikely in our view, as the group’s focus upon longer duration assets mean it could be hit hard in the event of a 2015 interest rate increase from the Federal Reserve and/or the Bank of England.  

Furthermore, after factoring in the acquisition and integration costs that Aviva expects to incur, consensus estimates for EPS already suggest that earnings will be lower in the current 2015 year.

These estimates are not likely to include any projections relating to changes in investment income as outcomes in this area are not possible to predict so far forward.

Given these factors and despite that, over the longer term, we expect the merger with Friends Life to be positive for Aviva; we feel that given the level of scepticism surrounding the deal the risk to the shares remains slanted toward the downside over the near term.

For this reason, and taking into account our assessment of the group’s valuation, we see no immediate reason to consider revising our price target higher. Therefore, we maintain our earlier target at 480.00 pence.

The next scheduled event of note for Aviva is the release of the Q1 Interim Management statement on 07 May 2015. 




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