Slow and steady hasn’t been doing all that great for Aviva (AVIVY) (AV.L) shareholders, as the shares of this large British life and property & casualty (or P&C) insurer have been a lackluster performer since my last update on the company, despite relatively good core operating earnings and major returns of capital through dividends and buybacks.
I’m not sure the company’s recent strategic direction is going to convert many skeptics. Acquiring more P&C operations may make sense over the longer term, but I expect investors to worry that Aviva is buying in at or near the top, while core trends across the business just don’t point to all that much growth.
Aviva shares do look undervalued, and that’s only assuming long-term core growth in the 2% to 3% range, but it may be hard to get investors excited about that despite a policy of high capital returns to shareholders and opportunities to grow the P&C business.
Healthy Trends Continue In Q1
Aviva’s most recent financial reports have been pretty positive, and that continued with the 2024 trading update. Aviva, like many European companies, only reports comprehensive financials twice a year, so investors have to extrapolate from relatively limited quarterly information in between those reports.
Premium growth in the P&C business was strong, growing 16% as reported or about 14% in constant currency. While that is not directly comparable to the sell-side estimate of 12% growth for the first half, it is at least a good start.
Growth was driven by the UK at 19%, with 27% growth in personal lines (auto and so forth) and 10% growth in commercial lines. Aviva continues to benefit from a UK auto market where rates are heading higher in response to claims inflation and the need for insurance companies to improve their reserves and capital. That said, claims inflation is still a challenge here too, as the combined ratio of 97.3 (versus 98.4 a year ago) is still above the 94% management target.
In the Canadian operations, premiums were up 7% in constant currency, with 12% growth in personal lines and flat performance in commercial. The combined ratio jumped here, from 89.5 to 96.3, with a sizable commercial loss to blame.
Protection & Health is showing more mixed results, with sales up 5% overall but Health down about 6%. The present value of new business increased 3%. Wealth did better, with 13% growth in the present value of new business and 15% growth in net flows, including 13% growth in Workplace (which accounts for close to two-thirds of AUM). Retirement PVNB improved 13%.
Aviva’s Solvency II ratio was pretty steady from the prior quarter at 206% (versus 207%) and still comfortably above the company’s 160%-180% target. While this spread gives management the flexibility to be more active on capital deployment, management is also using it as a buffer against some of the vagaries of interest rate uncertainty and credit risk in the investment portfolio.
Still Pivoting Toward Capital-Light Businesses, But With Maybe More Interest In Growth
Aviva spent a lot of time slimming down to its present form, shedding businesses in Asia and Europe and really refocusing on life/protection operations in the UK and P&C (largely personal lines) in the UK and Canada. The consequence of that was going to be a company that needed much less capital to operate, but that was likely to grow more slowly.
On the capital side, Aviva is certainly delivering. The spread between capital-intensive and capital-light businesses is now about 45% / 55%, with the life and legacy pension and savings businesses making up the bulk of the capital-intensive businesses. There’s still an opportunity to grow through pension risk transfer agreements (where companies transfer their pension obligations to an insurance company), and management is focused there, as well as on its Wealth and Health businesses.
The growth opportunity in Wealth is relatively straightforward – more people saving for retirement and having less confidence in government-backed plans – but Aviva has struggled over the years to really ramp this business. It’s going better now, but still a “we’ll see” type of story.
The story in Health is more interesting. Private health policies like the ones Aviva offer are basically meant to supplement what the National Health Service offers – private coverage gives you faster access to specialists and procedures, covers elective procedures and treatments or drugs that the NHS doesn’t cover, and can offer perks like private hospital rooms.
P&C is where things are getting more interesting, particularly with two relatively recent acquisitions. Aviva paid about 100m GBP for Optiom, a Canadian specialty insurer focused on the vehicle replacement insurance market (basically, policies that cover the gap between the what traditional car insurance pays for a total loss and the market price of an equivalent new car). This is a small deal and it makes sense in the context of rounding out Aviva’s significant Canadian auto insurance business.
The deal earlier this year for Probitas is more curious to me. Aviva paid 242M GBP for this specialty Lloyds insurer that operates in P&C and financial lines, with a focus on lines like construction, product liability, pollution liability, professional liability, and so on. The large majority of the business is written for the UK, Australia/New Zealand, and Canada, and the company’s combined ratios have been consistently better than average, while also growing premiums at a 21% rate since 2019.
It’s an odd move, I think. I can understand the appeal of another capital-light business, and Aviva management says they’ve been hampered in the past by a lack of access to Lloyds. Still, it seems like a move into an area where Aviva doesn’t have a lot of experience (raising execution risk), and I have some concerns that they’re buying at or near the top of the cycle.
The Outlook
With Aviva having returned 9B GBP to investors over the last three years and generating better-than-expected core operating profits, I can’t really complain about the job management is doing, and it does earn them some benefit of the doubt where these newer growth plans are concerned. What’s more, while management may be more interested in pursuing growth through capital-light businesses, they’re still committed to returns, with a target of returning 5.8B GBP or more over the next three years through dividends and buybacks.
Unlike U.S. insurers like MetLife (MET), which I discussed recently, I don’t see as much portfolio risk with Aviva. Over 60% of the portfolio is in bonds, and generally higher-rated bonds at that (A or better), and while about 20% is in mortgage loans, including commercial real estate loans, the European office real estate market is in much better shape than the U.S. market (better vacancy rates, better rent trends, etc.).
I’m still not looking for that much growth from Aviva – I think around 2% or so growth in core earnings is a reasonable expectation, particularly with management’s focus on returning capital. While it’s true that capital light businesses don’t need as much capital to grow, they still need some and there may be tension in the future between wanting to reinvest for growth and returning cash to shareholders.
Between discounted core earnings and ROE-driven P/BV, I believe fair value for Aviva is about 10% to 15% higher than today’s price (using a P/BV ratio of 1.55x). I’d also note that the dividend yield here remains quite high at nearly 7%.
The Bottom Line
I like Aviva’s shift toward capital-light businesses, and I can’t really complain about the execution since my last update. Still, I do have concerns that there just won’t be enough growth here to keep the Street interested and engaged. As much I like the potential for more capital returns and the current valuation, I think the shares are more likely to deliver an “okay” performance rather than something more exciting. Then again, there’s room in many portfolios for steady income-generators, so it may be worth a look for investors who want such an idea.
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