Based on its results over the past five years, Admiral(LSE: ADM)is one of Londons best insurance companies. The group is cash-generative, achieves a high return on equity and looks after its shareholders. The same cant be said for Aviva(LSE: AV), which has made numerous mistakes over the past five years.
However, if the City top analysts are to believed, this will change over the next three years now that Aviva has completed its deal to buy Friends Life.
A good deal
Up until last week, the City was broadly negative on the Friends-Aviva deal. But now that the deal has been completed, some analysts have started to issue positive research reports on the deal.
For example, analysts now believe that the Friends deal has completely transformed Avivas balance sheet, strengthening Avivas financial position. These forecasts are based on the fact that Friends is ahighly cash-generative company, with an overcapitalised balance sheet and little gearing.
Will take time
It will take a year or two for Aviva and Friends to fully integrate operations following their merger. So, for the next two years investors are unlikely to see any benefits from the deal.
However, by 2017 City analysts believe that the integration process will be mostly complete. With this in mind, analysts forecast that Aviva is trading at a 2017 P/E of 9.4, and the company will offer a dividend yield of 5.3% during 2017 up from the current yield of 3.2%. Further, if Aviva decides to up its payout ratio to 100%, the companys dividend yield could hit 7.3% by 2017. This figure is based on current cash-generation forecasts.
Nevertheless, as mentioned above these benefits wont flow through until 2017, which makes Admiral look like the better bet in the short term.
Analysts believe that Admirals shares will support a dividend yield of 5.5% this year, followed by 6% during 2016. However, Im concerned about the sustainability of this payout.
You see, as the second largest insurer of private cars in the UK, Admirals fortunes are driven by the UK motor insurance cycle. Moreover, increasing competition and falling motor insurance premiums are starting to affect to affect Admirals profits. Theres no telling if the company will be able to reverse this trend.
The companys pre-tax profit fell by 4% during 2014 and for the first time since the group became a public company, Admiral failed to post record results.
Overall, Aviva looks to be a better long-term play than Admiral. Avivas deal to acquire Friends Life will drastically strengthen the company and improve its cash generation.
On the other hand, Admiral already offers a market-beating dividend yield but an increasing level of competition in the UK motor insurance industry is starting to eat away at the companys profits.
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