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Aviva Plc Q3 Results Update – 04 November 2014

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 526.50
52 Week High 542.39 52 Week Low 411.18 P/E (Hist E) 10.9
Dividend Yield % 2.87 Dividend Cover 4.4 CEO: Mark Wilson
CFO: Tom Stoddard  Price Target  480.00

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Aviva shares go full circle

Since our last update Aviva shares have both set new highs for the year to date and come close to reaching new lows. This was as greater optimism over the earnings and dividend outlook for the group drove bids and offers higher through late August to early September, before panic selling amidst the global rout later in the month drove them back down to levels not seen since March this year.

The recent price action saw Aviva shares breach our target of 480.00 pence, reaching lows of 468.00, before staging a robust recovery.

Today the shares (525.00) sit just a few pence away from the level at which we last covered them, 519.00 pence, partly as a result of having been boosted by a positive third quarter update at the end of October.

Aviva Plc Share Price // Hourly Intervals

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Q3 Financial and operational performance update

Last week saw Aviva release its interim management statement for the third quarter of 2014, where management declared that “Aviva’s turnaround is delivering”.

The statement detailed a 15% uplift in the value of new business (VNB) for the period, with savings, annuities and protection sales from both Europe and Asia contributing heavily to the increase. In addition to this, the UK life operation returned to sales growth following a tumultuous first half.

Operational expenses also continued to fall, contributing to a minor reduction in the group’s combined operating ratio, which was down from 96.9% to 95.9% during the period. A similar improvement in the UK division’s combined ratio was also highlighted, with this falling from 95.5% down to 94.1%.  

In addition to improvement of the above metrics, the group also made progress toward leverage reduction targets during the first 9 months of the year. The latest figures show that external leverage stood at 46.7% as of the close of Q3 while the inter-company loan at was reduced to £3.6  billion as of the close of H1. The internal targets for both of these measures are 40% and £2.2 billion respectively.

With the better performance in terms of new business generation, costs, claims and leverage; management are also optimistic that cash remittances will improve for the full year; which is supportive of expectations for further dividend growth during the periods ahead.

All in all; measures targeting simplification, better cash flows, efficiency improvements and greater financial strength have been key pillars of the group’s strategy since Mark Wilson took over as CEO in January 2013.

Today the group has made progress in each of these corners however; the road ahead for the shares remains clouded with uncertainty.

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No real change to our outlook for Aviva Plc shares

In light of the positive Q3 update and an ensuing attempt at recovery from early October lows by the shares; it is worthy of note that consensus earnings forecasts for the group still see EPS for the full year coming in some 25% lower than in 2013 (48.00 pence).

Although we do not disagree that the group will struggle to top last year’s 64.5 pence per share, when taking into account Aviva’s first half performance (25.00 pence EPS) and management guidance for H2, we believe that there is scope for some degree of out-performance against the above consensus.

Nevertheless, earnings are still likely to be lower for the period and with the outlook remaining murky for mature market life and annuity operations (particularly the UK); we continue to see downside risks to the growth outlook for Aviva over the near term.

Even with our more optimistic outlook for EPS, it is unlikely that this and the existing valuation will be enough to substantially boost the share price in the immediate future.

This is as the market has continuously exhibited reluctance to rate the shares on a par with the wider sector for some time now and we do not see any catalyst on the horizon that would give cause for this to change.  

Going further, we actually see scope for the discount to competitors to continue; most notably because of ongoing uncertainties over the group’s capital position. While it has made notable progress throughout the last 18 months in this regard, Aviva still has insufficient capital to cope with a 1:200 year event without drawing on the inter-company loan. It will need to pay down a further £1.4 billion to be able to meet the requirements of such an event.

Moreover, in an environment where earnings are falling and management are balancing shareholder demands for cash returns with the incompatible task of balance sheet repair; it becomes plain to see that the road ahead for the group is not without risk.  

Should it fail to pay down the inter-company loan balance within a suitable time frame then the shares could once again, attract the wrong kind of attention from investors and regulators alike.

Adding to this is the looming deadline for the implementation of the EU’s Solvency II regime, which will see Aviva officially designated as a Global Systemically Important Insurer and subjected to increased regulatory scrutiny.

All in all, the priority for management at Aviva is likely to remain the capital position of the company and while the outlook for dividend growth is positive at present, this could change at any time in the event of downturn at either of the group’s major divisions.

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The takeaway

As a result, we expect that Aviva shares will struggle to maintain a break above the 540.00 pence level for the time being.

On this note, we also believe that the risks for Aviva remain weighted toward the downside over the near term and for this reason, we continue to see 480.00 pence as a fair price for the shares.

This corresponds with the 23.6% long term retracement level (18/04/2013 @ 292.00 – 19/09/2014 @ 540) and also implies an earnings multiple of 10X at the industry consensus of 48.00 pence EPS for 2014, which remains in line with the group’s recent average.  

Accordingly, we maintain our previous price target at 480.00 pence per share in anticipation of a further downwards rerating back to this level.

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