JHVEPhoto/iStock Editorial via Getty Images
At the Lab, we are excited to comment on Aviva plc (OTCPK:AIVAF) (OTCPK:AVVIY) once again. Following our previous publication stating that Aviva was not a potential takeover candidate, we continued to emphasize the company’s undervaluation. At that time, the company was a unique opportunity for investors, especially considering a 2024 total yield of 12% (Remuneration Story In Place) coupled with a solid Solvency II ratio. Considering Aviva’s latest positive results (Fig 1) and a new achievable outlook by 2026 (Fig 2), it is a good moment to update our readers.
Aviva 2023 Results in a Snap
Fig 1
Aviva New 2026 Target
Fig 2
For our new readers, Aviva is a UK-based insurance and retirement business company. Its services include life insurance policies and savings and pension annuities. Aviva’s main GEO locations are the UK, Ireland, and Canada.
Starting with the Amanda Blanc words (Aviva Group CEO), the company has:
made significant progress in 2023. Sales are up, costs are down, and operating profit is 9% higher. Our position as the UK’s leading diversified insurer, with major businesses in Canada and Ireland, is delivering.
Why are we still positive?
Firstly, we see limited downside risk to Aviva’s £2 billion operating profit expectations by 2026. In addition, the company targets £1.8 billion Solvency II own funds generation. Here at the Lab, we believe the company has strong earnings growth potential in the General Insurance division, which was recently enhanced by a bolt-on acquisition. To support the company’s capital generation, the Aviva contractual service margin (CSM), which represents the unearned profit from a group of insurance companies at any given point in time, is starting to bear fruit. This should deliver a relatively stable source of earnings growth projection. This was already evident in the 2023 financials. In numbers, Aviva reached a plus 12% on the CSM growth to £851 million (Fig 3).
Secondly, the company is the only major UK composite insurer with GEO diversification. Here at the Lab, we also cover L&G with a buy rating. However, looking at peers such as Phoenix and Direct Line, Aviva covers both life and non-life/general insurance. In addition, there is a solid franchise in Canada. This diversification provides support on where Aviva forecasts the greatest return on capital. Even if we are not pricing this optionality, the company might also grow in the UK Annuity market. One of our L&G upsides is based on annuity growth. In detail, in the UK, annuity sales increased to a value of £5.2 billion, with a 46% uplift compared to 2022 results. According to the Association of British Insurers, the number of annuity contracts sold increased in 2023 to 72,200 (+34% in 2022). As reported, this is the most significant number recorded since 75,000 were sold in 2016, reflecting a strong consumer desire to lock in a guaranteed income for their later years. Looking at the Aviva division, in 2023, the Individual Annuities division grew by a plus 17% with solid margins; therefore, we believe there is space to maneuver.
Aviva’s capital position remains solid. The company delivered a Solvency II ratio of 207%, which was slightly ahead of Wall Street expectations set at 205%. This was performed by a robust set of earnings. For this reason, Aviva decided to upgrade its DPS guidance to mid-single digit. In addition, it included an additional £300 million buyback. More important to report is the Group sensitivity (Fig 5), which shows that the company screens with moderate market risk. Considering the most extreme recessionary scenarios, the company’s solvency II ratio might fall by 45 percentage points and will still remain at the 160% regulatory target. In addition, the company further decreased by £1.2 billion.
Aviva CSM upside
Fig 3
Aviva Annuities upside
Fig 4
Aviva Sensitivities Table
Fig 5
Earnings changes and Valuation
Following Aviva’s new 2026 estimate, we updated our numbers. With a total return yield of >10% (made by a growing dividend and a recurrent buyback), Aviva may achieve its CoE (Cost of Equity) in capital return. For this reason, the company deserves a long-standing buy.
That said, the company is improving earnings diversification towards more asset-light lines of business, such as individual annuities. This also provides more balance sheet flexibility for M&A upside. As already reported, the company has once again been highlighted as a takeover target. Still, the company valuation looks cheap.
In our 2024 estimates, we projected operating profits of £1.71 billion and were 5% ahead of consensus. Today, we are not updating our 2024 numbers and remain flat with our previous forecast; however, we estimate higher operating profit growth towards 2026. In detail, thanks to lower central costs, M&A contribution, and the UK general insurance number, our operating projections arrive at £1.95 and £2.1 billion in 2025 and 2026, respectively. For this reason, our 2025 EPS reached 52.5 pence. Looking at the peers’ multiple, M&G, L&G, and Phoenix trade at a 10x P/E and offer a lower total return yield. We believe Aviva deserves a premium valuation compared to its peers, but applying the peers’ P/E multiple targets in our EPS estimate, we lift our price target to 525p. This upgrade valuation is also driven by higher own-funds capital generation and does not include benefits from a higher interest rate.
Risks
Downside risks include no announcement of special capital returns and buyback postponement (the company returned more than £9 billion in dividends and capital over the last three years), and value investors might look for alternative investments. The company is not immune to volatility in equity and fixed-income investments (credit risks and default rate). In addition, we should also report regulatory and longevity risks. Going into the business, the company might be impacted by a higher combined ratio evolution over the cycle. In addition, we are 4-5% ahead of the company’s estimates on an operating profit target.
Conclusion
We still believe Aviva is undervalued, with a capital return yield above 10% on the medium-term horizon. In addition, the company offers good diversification and modest risk with well-managed sensitivities in a downside environment. Given Aviva’s optionality growth and solid balance sheet, the new 2026 outlook is achievable. For this reason, we are reiterating our buy rating.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.