After years of underperformance, Aviva has been winning back confidence from investors. But those expecting the London-based group to win big from the jump in gilt yields unleashed by September’s mini-budget would be disappointed.
The rise in interest rates in recent months boosted its level of surplus capital to £2.5 billion at the end of the third quarter, up from £2.3 billion at the end of June. Even after paying the interim dividend, completing the acquisition of Succession Wealth and redeeming roughly £500 million in debt, that coverage ratio stood at 215 per cent, far above the 180 per cent upper threshold of its target range. On a pro-forma basis, that represents an increase of two percentage points on the end of June.
Yet that is less of a benefit than investors looking to interest rate sensitivities outlined in the interim results might have expected. Then, management said a 100-basis-point increase in rates would provide a 15-percentage-point boost to the Solvency II coverage ratio. The actual gross benefit from capital generation and market movements was only five percentage points.
The difference between expectation and reality? One, a quarter of Aviva’s assets are invested in non-UK instruments such as Canadian gilts, which recorded less of a bounce. Two, the greater exposure the company has to long-dated bonds, according to Charlotte Jones, Aviva’s finance chief. By September 30 the yield on 30-year gilts was down to 3.8 per cent, still a jump on the 2.6 per cent yield offered at the end of June but lower than the peak of almost 5 per cent days earlier. More importantly now, the decline in gilt yields since the start of October has had a minimal impact on the coverage ratio.
Betting the farm on big acquisitions seems unlikely. Amanda Blanc, the chief executive, has been at pains to slim down a bloated structure. More returns to shareholders are on the cards, with buybacks slated for the full-year results in March. Analysts at RBC Capital think annual buybacks worth £450 million are possible in the medium term, starting with £300 million over the next two years.
Plans to hand back £870 million this year and £915 million next year via ordinary dividends remain, a payment of about 31p and 32.7p a share. At the present price, next year’s payout would offer a potential dividend yield of 7.7 per cent.
The rise in surplus cash has been accompanied by a re-rating in the shares, which have continued their ascent this year. They trade at just over eight times forecast earnings, better than Legal & General, but still in the bottom half of the sector. Unlike L&G, Aviva has no liability-driven investment business.
Capitalising more on the rise in gilt yields by boosting the volume of bulk annuity business written could help to spur a further re-rating in the shares. Higher yields should allow more pension schemes to reach the funding position required to offload their liabilities to insurers. Bulk annuity volumes year-to-date are only £2.9 billion, down from almost £4 billion over the same period last year. The fourth quarter is expected to be busier for new business.
Inflation in the general insurance business also remains a challenge. The combined ratio, a key measure of profitability, worsened to 94.3 per cent, but there are signs that claims inflation in the British motor market is easing. Inflation in this business declined to 8 per cent to 10 per cent, down from 12 per cent in the second quarter, in line with the fall in used car prices.
Ultimately, if insurers are judged on their ability to generate strong levels of capital, then there is still more reason now than for many years to have conviction in the strategy of Blanc & Co.
ADVICE Buy
WHY An improving level of surplus capital could mean higher returns for investors
ITV
Trying to get investors to focus more on the launch of its shiny new streaming platform and less on the deterioration in advertising spending is not a marketing feat being managed by ITV.
Warning that total advertising revenue is expected to decline by between 1 per cent and 1.5 per cent this year, worse than the broadly flat performance analysts had expected, wiped more value off the shares. That’s even after the boost in spending that should be derived from screening the World Cup in Qatar.
Investors might be more forgiving if the rest of the business wasn’t also challenged. The Studios business might be expected to grow revenue ahead of the 5 per cent target next year, but it also faces heightened cost inflation, which means margins are likely to be at the lower end of the 13 per cent to 15 per cent range.
A darker outlook for advertising spending puts plans to splurge on the launch of ITVX, which will replace the ITV Hub and the ad-free ITV Hub+ service, into sharper focus. Spending on content, data and technology and marketing the streaming platform is expected to total £195 million next year and £185 million between 2024 and 2026. That’s in the hope of generating annual digital revenue of at least £750 million by 2026 and diversifying the revenue stream away from advertising on linear television.
Investors aren’t convinced it is a transition the broadcaster can pull off. The shares have fallen by 37 per cent to 70p since the start of this year alone. That leaves them trading at almost seven times forward earnings, below the long-running average multiple of ten.
Before the release of third-quarter figures, analysts had expected earnings of 10.3p a share next year, a decline on the 13.3p figure pencilled for this year, which reflects the heightened spending. Cuts to forecasts for next year seem likely. Analysts at Numis had forecast a decline in total advertising revenue of 1 per cent next year, but now think that might be optimistic given the wider economic pressures.
Given that further pressure on advertising revenue seems likely, the shares being cheap shouldn’t be seen as a buying signal.
ADVICE Avoid
WHY Drop in ad spending will hit earnings hard
