Good news has been in short supply for investors this year, but Aviva is becoming better at confounding the market’s (admittedly low) expectations. Higher annuity volumes, cost-cutting and sturdy underwriting pushed the insurer’s operating profits up by 14 per cent during the first half of the year, beating consensus forecasts. Yet it is the sniff of more special returns that has caught the market’s attention.
Rising interest rates and robust capital generation from within the business have left Aviva with a Solvency II capital ratio of 234 per cent. That metric falls only to 213 per cent even after accounting for another £1 billion in debt repayments and funding the acquisition of Succession Wealth.
The company deems anything over 180 per cent as excess that can be used to fund bolt-on acquisitions and special returns to shareholders, which means a share buyback programme is slated to commence next March.
Aviva has roughly £2.3 billion in capital above that 180 per cent target ratio, but £1.8 billion of that was generated thanks to the benefit of rising interest rates rather than the business operations themselves, so investors should temper their expectations over how much will end up in their pockets. Analysts at Jefferies reckon that capital return will amount to £250 million, which, in addition to the £4.75 billion already handed back to shareholders, would put special returns at the £5 billion figure demanded by Cevian, the activist investor.
The trading figures sent Aviva’s shares up by more than 12 per cent, helping to close the valuation gap between it and its peers. The shares now trade at almost nine times forward earnings, finally aping Legal & General, its closest competitor.
Aviva has a long record of underperforming its peers, but over the past two years Amanda Blanc, the chief executive, has been chipping away at that lead. She has cut the deadweight, selling eight international businesses, and is focusing on driving returns within the life and general insurance markets in Britain, Ireland and Canada. Despite rampant inflation, the group has retained a target to save £400 million in costs by 2024.
Rising interest rates are a boon for insurers, but capital generation from Aviva’s business itself is also flowing more strongly. Within the core UK and Ireland life business, bulk purchase annuity sales were the driving force, 15 per cent higher at £1.9 billion and written at better margins.
Bulk purchase annuities are one of the few growth opportunities within the insurance market as more companies seek to remove risk from their balance sheets and offload their pension scheme liabilities to insurers. Higher interest rates puts that goal in reach of more pension schemes as funding positions improve to the point where insurers are willing to transact with them. Aviva expects bulk annuity sales volumes to be even higher during the second half.
What else does Aviva have in its corner? A large back book of annuities, which pay out a fixed amount to the holder. As those policies mature, the capital held against them can be reinvested at higher interest rates, which should prove a kicker to returns.
Claims inflation has cast a shadow over the general insurance market, particularly over how companies will balance rising motor and home repairs costs with pricing to customers feeling the cost of living pain.
Aviva said the customer retention rate had risen by between seven and eight percentage points within the motor and home insurance businesses, even if customers were opting for value products rather than those with bells and whistles. The general insurance business was more profitable than analysts had expected during the first half. If Blanc can keep capital generation on course, Aviva could earn more plaudits from the market.
ADVICE Buy
WHY The shares offer a good dividend yield backed by rising capital generation
CLS
For institutional investors that have piled into hot parts of the property market, rising interest rates sound a warning bell for returns. For CLS, steering clear of the pricier London market and focusing on non-prime locations has given the office landlord a greater buffer against increasing debt costs.
The commercial property group lets offices in London, the southeast, France and Germany. In central London and the capital’s West End, rising office values have pushed down property yields, which roughly represent the rental income that a landlord can expect to generate relative to the value of the property. The average yield on CLS’s portfolio is 4.9 per cent, higher than its UK-listed peers focused on the mature, central London markets. At 2.26 per cent, its average cost of debt is also lower. About 80 per cent of the debt is at a fixed rate and a quarter of the remainder, which is charged at a floating rate, is capped.
Then again, the looming recession could force rents down and cause property prices to fall. That is a fear reflected in the hefty 38 per cent discount baked into the share price versus CLS’s net tangible asset value at the end of June, a level that looks too harsh.
Over the first half of the year, the value of CLS’s portfolio was broadly flat, dragged down by leasing offices in France below market rates but saved by a recovery in the beaten-up British market. In Germany, the standout performer for CLS over the past five years, valuation growth slowed to 0.3 per cent. Thus far, rents have held up well and new leases and renewals were agreed at 4.4 per cent ahead of estimated rental values. There are no leases subject to open market rent reviews, 65 per cent of leases have fixed uplifts and a further 24 per cent have stepped increases baked into the agreements.
That discount has prompted the company to implement a share buyback, which will return £25.5 million to shareholders.The 250p purchase price represents a 20 per cent premium to Tuesday’s closing price.
ADVICE Buy
WHY High discount baked into the shares looks too harsh
