When I last wrote about Aviva (LSE: AV) in July, I thought the share price looked good value. The stock has since risen by almost 20% — so does my view still hold?
I reckon the answer is yes. I think Aviva shares could still be cheap. Here’s why.
Why have the shares risen?
Aviva surprised investors earlier this week with plans to launch another share buyback, supported by better-than-expected financial results.
The FTSE 100 insurer has already returned £4.75bn to investors this year, funded by various disposals. CEO Amanda Blanc’s latest plan is for a further buyback to be launched with the company’s 2022 results.
The aim of the buyback would be to return surplus capital to shareholders. Doing this would reduce the company’s surplus cash to its target level.
Right now, Aviva’s figures show £8.7bn of surplus capital. That’s equivalent to 212% of the amount required by the UK regulator. Blanc is targeting a coverage level of 180%.
My sums suggest this means Aviva might be able to return a further £2bn to shareholders, assuming the company doesn’t opt to use the cash for acquisitions or other investments.
In reality, I think the next buyback will probably be smaller than this. But even a smaller buyback should provide support for the share price and help boost future earnings.
One big number
Big insurers are complicated businesses. But I think it’s quite easy to find out whether they’re operating successfully by monitoring their cash generation. Most big insurers report this figure directly for investors.
For example, Aviva reported “cash remittances of £798m” for the first half of the year. This is cash that has been returned to Aviva’s holding company by its operating businesses. This cash can be safely used to fund dividends and share buybacks.
Aviva’s guidance is for total cash remittances of £5.4bn between 2022 and 2024. To put this in context, Aviva’s forecast dividend for 2022 will cost around £935m. Over three years, that’s about £2.8bn.
These numbers suggest to me that if things continue to go well, Aviva should be able to increase its dividend and fund more share buybacks over the next couple of years.
Why I think Aviva shares are cheap
Aviva shares offer a well-supported 7% dividend yield and trade on about 11 times forecast earnings.
Despite this modest valuation, the business is growing and appears to be coping quite well with inflation. Aviva reported a 6% rise in insurance premiums during the half year, together with a 12% increase in sales of annuity and equity release products.
The main risk I can see is that claims costs could continue to rise. This might force Aviva to choose between cutting its prices or losing business to competitors offering cheaper prices. If this continued for too long, it could put pressure on the dividend.
I’m not sure how likely this is, but I’m reassured by the steps CEO Blanc has already taken to cut debt and strengthen Aviva’s profitability. I think Aviva should be able to trade through a recession, without cutting its dividend.
On balance, I think Aviva shares still look good value at current levels. I’d certainly be happy to buy them for my portfolio.
