Aviva Undervalued As It Nears Completion Of Its Corporate Makeover

 

Aviva (OTCPK:AIVAF) management has continued to execute well on its plan to transform the company into a more predictable insurance company focused on retirement, protection, and P&C insurance, and one more likely to spin off meaningful capital returns to investors in the years to come. Despite that steady execution, the shares haven’t done all that much, with a total return of around 6% since my last update – close to the S&P 500 and better than peers like Legal & General (OTCPK:LGGNY) and Phoenix (OTC:PNXGF), but still a little less than the 8%-10% I had hoped to see.

Reconsidering the company today, I think the shares are around 15% to 20% undervalued, but with the business likely to grow around 4% henceforth, value realization will likely take some time. I do see good opportunities in the P&C operations and in the bulk annuity/pension insurance operations, but this is very much a “slow and steady” type of proposition for investors.

 

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Aviva Undervalued As It Nears Completion Of Its Corporate Makeover

Aviva Fully Committed To A Simpler, Lower-Return Model

I don't want to push the similarities too far, as they're very different businesses, but the U.K.'s Aviva (OTCPK:AVVIY) certainly seems to have taken a few pages from MetLife's (MET) playbook - simplify the business, cut costs, and focus on core operations.

Aviva's strategic pivot should create a more consistent business that generates cash flow to support a healthy dividend, but there's no escaping the fact that the new Aviva will be a lower-return, slower-growing business than the prior iteration. That's not necessarily a bad thing - it's better to be a well-run slower-growing business than an ineffectively-run business with faster growth potential - but it does mean that investors should adjust their expectations accordingly.

I do believe that the "new Aviva" is undervalued, with a long-term total annualized return potential in the high single-digits, but with a long-term earnings growth potential more likely to be in the low-to-mid single-digits at best.

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Aviva Fully Committed To A Simpler, Lower-Return Model

Aviva On Track And Undervalued

European insurers have continued to underwhelm this year, with names like Prudential PLC (PUK), AXA (OTCQX:AXAHY), Legal & General (OTCPK:LGGNY), and Aviva (OTCPK:AVVIY) all down on a year to date basis, making companies like Ageas (OTCPK:AGESY) more the exception than the rule. While there are company-specific issues in play and some macro concerns (including Brexit), a bigger issue is the underwhelming pace of growth in both reported earnings and book value.

As it concerns Aviva, although these shares have not done as well as I would have expected, I continue to believe that slow and steady can win the race. The company has made what I believe is a good case for how it will grow in the U.K. life market, and continues to invest in growth opportunities in insurance markets like Poland. Although I don’t expect exceptional growth, low-to-mid single-digit earnings growth is enough to support a fair value in the mid-teens (for the ADRs) and management remains committed to returning capital to shareholders.

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Aviva On Track And Undervalued

AXA's Accelerated Transformation Carries Bigger Risks

France's AXA (OTCQX:AXAHY) has never been afraid to do things its own way, and the company's past efforts to shift away from more capital-intensive savings-oriented life products in favor of protection-oriented products made it an early mover in what proved to be a sound strategic shift. More recently, management has been working to strip administrative costs out of operations, grow its P&C and health insurance products, shift more capital towards faster-growing regions like Asia, and begin selling down its U.S. operations. The biggest move, though, has also been the most controversial - the $15 billion-plus acquisition of XL Group (XL).

I don't fault the reasoning for making a large acquisition in P&C insurance/reinsurance, and I can see the positive leverage opportunities in acquiring a Bermuda-based reinsurer like XL Group. I'm not sure this was the right company, though, and I think at least some of the share price weakness has been a reasonable reaction to those concerns. While AXA does appear to trade at a double-digit discount to fair value, I'd just as soon own a company like Prudential plc (PUK) or Aviva (OTCPK:AVVIY) at this point.

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AXA's Accelerated Transformation Carries Bigger Risks

Aviva Executing, But The Stock Continues To Test Patience

There are many types of value traps, but one of the most frustrating is when a company executes on its self-improvement plans but can't get much love from the market. Such is the case with Aviva (OTCPK:AVVIY), which has continued to underwhelm in the market since my last update, particularly when compared to the likes of Prudential plc (NYSE:PUK), AXA (OTCQX:AXAHY), and Legal & General (OTCPK:LGGNY). 

The company has done well with its acquisition of Friends Life and subsequent restructuring efforts that have seen it sell down stakes in non-core areas and boost performance in areas like asset management. Nevertheless, the market still seems skeptical about the company's ability to generate meaningful growth and translate excess capital into liquid capital that can be returned to shareholders. Although I don't expect Aviva to be any sort of growth champion, I do believe the company can grow at a mid-single-digit rate, supporting a fair value about 20% higher than today's price.

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Aviva Executing, But The Stock Continues To Test Patience

Seeking Alpha: A Bigger, Better, But Less-Loved, Aviva

The past year has been a little unusual for Aviva (NYSE:AV). That the shares of this large European insurance company haven't performed well isn't so unusual, as Allianz (OTCQX:AZSEY), AXA (OTCQX:AXAHY), Prudential Plc (NYSE:PUK), and Legal & General (OTCPK:LGGNY) have all seen so-so results from their ADRs, due in no small part to adverse currency moves. What makes Aviva unusual is that the company undertook a sizable M&A transaction that significantly improved its capital position and should deliver meaningful revenue and cost synergies, but the market has been underwhelmed to say the least.

I understand the skepticism to a point. Euro insurance M&A hasn't often delivered the targeted synergies and in many cases it has led to a prolonged period of underperformance (has been the case with Aviva in the past). I think it's worth noting, though, that Aviva is led by a different team now and one that has done well with past cost-reduction efforts. I don't think a mid-teens ROE is an unreasonable goal for the new leader in U.K. life and protection, and these shares look as though they could be 20% undervalued today.

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A Bigger, Better, But Less-Loved, Aviva

Investopedia: Allianz In Relatively Good Shape

Investors are understandably reluctant to put money into companies tied to the health of the European financial system. As one of the biggest, but also one of the best, insurance companies in Allianz (OTC:AZSEY) might be a company worth an exception. While low rates do compromise the company's ability to grow, quality underwriting and a healthy balance sheet make Allianz a value-priced name worth considering.

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http://stocks.investopedia.com/stock-analysis/2012/Allianz-In-Relatively-Good-Shape-AZSEY-AXAHY-AV-MET-PUK0622.aspx

Investopedia: Aviva In The Wrong Place At The Wrong Time

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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http://stocks.investopedia.com/stock-analysis/2012/Aviva-In-The-Wrong-Place-At-The-Wrong-Time-AV-PUK-HIG-MET0621.aspx

Investopedia: The Japanese Earthquake's Effects On Insurers

Although it is still far too early to fully assess the scale and impact of the severe earthquake that struck northeastern Japan, and all of us at Investopedia wish our friends and readers in Japan the best, the fact remains that markets have to digest this information and move forward. To that end, it seems quite likely that major reinsurance companies are going to face large claims in the wake of this disaster. 

The Scale of the Disaster 

As of this writing, which is only hours after the quake struck, it is all but impossible to get a firm sense of the damage in the Tohoku region of Japan. While the reported magnitude of this quake is considerably higher than that of Great Hanshin quake that struck Kobe in 1995, it does not automatically follow that this quake will surpass the fatality (over 6,000 dead) or economic damage (roughly $100 billion) of that prior disaster. Let us all hope it does not.

Nevertheless, there are many major manufacturing facilities in this region owned by companies like Sony (NYSE:SNE), Toyota (NYSE:TM),and Nissan (Nasdaq:NSANY) to name a few. What's more, given the reports of infrastructure damage that have already come in (roads, bridges, and the like), it seems probable that there has been significant economic damage.

Please read the full piece at Investopedia:
http://stocks.investopedia.com/stock-analysis/2011/The-Japanese-Earthquakes-Effects-On-Insurers-BRK.A-RNR-SWCEY-ACGL-ACE-XL-RE0311.aspx

Is Tower Group Leaning A Bit?

Interesting results from Tower Group (Nasdaq: TWGP) tonight. Although the company beat estimates for the quarter, the company's guidance for next year is pretty uninspiring. Barring a good explanation or abject conservatism on the call (a nicer way of saying “sandbagging”), I expect this stock will be weak.

Tower announced that gross premiums rose almost 33% in the fourth quarter, while the combined ratio was below 92%. Even more impressive is the company's 31.8% expense ratio – a slight improvement from the third quarter and the lowest level Tower has seen in years. It is also interesting to see that the company has a significantly lower loss ratio in its personal segment (48.1%) than in its commercial segment (66.5%). It seems to be an unfortunately reality that the company's acquisitions have lead to a higher loss ratio than in the past.

Insurance markets are still not particularly healthy for the company. To that end, the company saw rates rise 3% overall on its renewal business (5.2% in personal, 1% in commercial), with an overall retention ratio of 82%. That tells me that insurance companies are happy to compete on price and are likely pricing business for a loss. Any veteran reader of Berkshire Hathaway's (NYSE: BRK.A) annual reports will know that Warren Buffett often talks about how most insurance companies operate with underwriting losses and this is part of the reason why – losing discipline on price to get business.

Making matters worse, this is not a great investment environment for insurance companies. Although recognized investment income jumped 40%, the yield declined to 4.7% from 5.5% a year ago.

Turning back to the guidance issue, the company is looking for earnings of $2.70 to $2.90 next year. Taking the midpoint, that means about 10% growth. That does not bother me as much as the implied ROE – something on the order of 10% or so and well below what the company has offered before as a target of 13-15%.

To an extent, I can see how the company gets at this number. The pricing environment gives the company the losing choice of either refusing to write bad policies or seeing customers walk away from fair prices and buy their insurance from less disciplined companies. Moreover, the investment environment is doing them no favors now and it wouldn't seem that there's obvious leverage left on the expense side.

Factoring in a new lower ROE (13%) and maintaining a discount rate of 11%, I get a price target of $32.25 for these shares. That's not a terrifically exciting target price, particularly in this kind of insurance market. I might be wishy-washy on holding a stock with such modest appreciation potential, but I think there is a lot of quality in Tower Group and I think the company can lever its recent acquisitions over time. Moreover, I do think that, over time, mid-teens ROEs are certainly possible.

I always keep an eye on the insurance sector, but there is not a lot that excites me today. MetLife (NYSE: MET) and Aviva (NYSE: AV) look kind of interesting, and Ace (NYSE: ACE) and Arch Capital (Nasdaq: ACGL) are kind of cheap. Beyond that, though, W R Berkley (NYSE: WRB) is the only intriguingly cheap insurance company on my list.

So, I'll sit tight for now but I can't deny a bit of an itch to switch over from Tower Group into WRB at today's relative valuations.

I would HOLD shares of Tower Group

Disclosure: I own shares of Tower Group