Aviva In The Wrong Place At The Wrong Time

By Stephen D. Simpson, CFA | June 21, 2012 AAA

Even though investors are encouraged to focus on the long term, timing still has a lot to do with share price performance. In the case of global (but UK-focused) insurance company Aviva (NYSE:AV), timing really isn't on the company's side. While this looks like a pretty respectable long-term business, balance sheet issues may well force the company to sell assets at a time when valuations are quite low.

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Current Results OK, but Showing Some Stress
Aviva's present results aren't terrible, but they certainly show that growth is not easy to find in a business heavily weighted towards Europe.

Life and pensions saw a 7% decline in premiums (on a continuing operations basis), with major declines in markets like Ireland, France, Spain, Italy, Poland and China. The U.K. business was not terrible (down 3%), and the U.S. results were actually up strongly though on an easy comp. With good overall investment sales, the combined "long-term savings" (life insurance and annuities, mostly) saw a 5% year-on-year decline. The smaller general insurance business fared better though, with flat year-on-year premium revenue.

Capital Forces a New Direction
Compared to other European insurance companies like Allianz (OTC:AZSEY), AXA (OTC:AXAHY), Prudential PLC (NYSE:PUK), and Old Mutual (OTC:ODMTY), Aviva is pretty heavily leveraged. That has allowed the company to push up its returns on equity and post better earnings performance, but Aviva is now having to pay the piper.

The markets have turned against highly-leveraged insurance companies and Solvency II regulations are going to force the company to reduce that leverage. What had been a tailwind for the company, then, is now set to be a headwind.

Unfortunately for Aviva, this is a tough time to restructure its business. The company is going to talk to investors about its plans on July 5th, but the general assumption now is that it will sell down its Delta Lloyd stake, sell its U.S. business (which is mostly variable annuities), and maybe also sell some combination of the Canadian, Spanish, Italian, and Polish businesses.

Selling down Delta Lloyd and selling the U.S. business make a certain amount of sense; they have added a lot of volatility to the business and the variable annuity business (in general) has come to be seen as more trouble than its worth. Unfortunately, this is the wrong time to be selling these businesses. The cost of equity has soared for the insurance sector and life insurance and annuity businesses are not in demand at all. What's worse, Hartford (NYSE:HIG) is looking to sell its life business as well and there's a limited number of potential buyers (MetLife (NYSE:MET), Lincoln (NYSE:LNC), and Prudential (NYSE:PRU)).

SEE: Investing In Health Insurance Companies

The Bottom Line
With Aviva forced to sell assets and raise capital at a time when its assets carry trough values and share capital costs dearly, to say nothing of the need to find a new CEO, it's likely that the next few years aren't going to be too impressive in terms of reported financial performance. So while the company has a solid UK/European insurance business, it's going to be hard for the company to outperform - outperformance may have more to do with getting better prices for its assets than anything else.

Perhaps not surprisingly, Aviva's shares are not robustly priced. Even granting a bottom-basement price for the U.S. business, high single-digit return on equity in five years' time would still support a low teens share price. There's value here, but investors need to be realistic about the challenges in front of the company, the probability of a dividend cut, and the possibility that these shares will struggle to move substantially higher until a clear plan is in front of investors.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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