Insurance is funny business. Its also a paradox of sorts. At one level the insurance company does its best to get you out of trouble if/when you find yourself in a pickle. On the other hand, the entire business model is designed to ensure that the insurer is better off (financially) than its customers.
The reason the concept as a whole works is based on risk. If your house was destroyed by a natural disaster, for instance, you could be ruined financially. Its a risk customers of insurance companies arent willing to take.
So, if the company ultimately wins out, why not get behind it? Well, you might decide not to if management is underperforming or if the insurer has a terrible track record, but let me outline why Aviva (LSE: AV) (NYSE: AV.US) is a company that you might want to back.
After tax, it made a 2 billion profit last financial year. Thats against a 2.9 billion loss the previous year. The profitability of Avivas general insurance business decreased slightly to 97.3% (2012: 97.0% a figure below 100 indicates profitability) but remains sound.
The board is pushing hard on a restructuring or turnaround programme. Analysts have mentioned that despite not seeing any real fruit from this turnaround project, theyre genuinely impressed by managements commitment to it. Despite disappointment from analysts, youd have to be impressed by some of the cost reductions Aviva has achieved: integration and restructuring costs were 21% lower during the past financial year; operating expenses were also down 7%. Overall the board has indicated it would like to deliver a 400 million reduction in expenses. From what Ive seen it should get there.
Bottom line: revenues fell over 20% during the period, so you can see why the cost-cutting agenda is in full swing. Impressively, Aviva produced a profit margin of a little over 3%. Aviva has room to improve and it knows it.
If you look around the world, the story is much the same. Companies are struggling for earnings growth of more than 3-4%. Cutting costs to boost profitability has become the norm. Avivas clearly committed to this aspect of the business. My concern is that the income generators of the business will be lacking in the years to come. Management argue things are looking up I have no reason to doubt them.
Its the old hip-pocket nerve the pain of financial sacrifice. Aviva deserves a star for its commitment. Some 400 senior people at Aviva did not get a pay rise last year. No executives received bonuses in 2012, either. I might be old-fashioned but I think that produces incentives for employees to work harder in order to boost profitability. And on that front there is hope. The value of new business increased 13% last financial year primarily driven by France, Asia, Poland and the UK.
When you combine Avivas metrics with commentary from management, I think things start to become a little clearer. The stocks on a price earnings multiple of 14 times. Its earnings per share is 0.3, and it has a dividend yield of a little over 3%. The line from management: Have we unlocked the full potential at Aviva? No, there is more to come.. I suspect thats probably true.
Dont expect Aviva to shoot the lights out, but it could be a quiet performer in the market over the medium term. Just look at the dividend forecast: 24 analysts covering the company expect dividends of 0.17p for the upcoming fiscal year, an increase of over 11%, according to the Financial Times. That works for me.
You can’t invest in the share market without taking on some risk. I view this particular financial services play as a calculated risk. It’s a risk because there’s no tangible evidence yet of solid earnings growth, but it’s calculated because management have a proven track record of effective cost-cutting and insist they are on track to produce more shareholder value. In the meantime, the company’s basic fundamentals look okayand the dividend seems stable enough.
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David Taylor has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.