Cube UK Report (26 March) – Aviva’s “substantial” capital return

Cube UK Report (26 March) – Aviva’s “substantial” capital return

Good morning, it’s Roland here with Friday’s edition of the Cube Report.

Newsflow is a little lighter today, but there are a couple of interesting items I’d like to look at.

  • Aviva (AV) – another big disposal has left the insurer with surplus cash
  • Smiths Group (SMIN) – half-year results


  • Stock data should display here.
Market cap £15.7bn
RNS Sale of Aviva Poland
Writer disclosure Long

FTSE 100 insurance group Aviva is a substantial holding in my personal portfolio, so I’ve been interested to see the changes being made by newish CEO Amanda Blanc.

When Ms Blanc took charge she promised to act at pace. So far, she’s delivered. Today’s RNS details the sale of Aviva’s Polish business to German rival Allianz for €2.5bn in cash. This valuation is said to equate to 16.9x IFRS (statutory) after-tax earnings and 5.7x IFRS net asset value. I’m not expert, but that seems reasonable to me for a mature(ish) insurance business.

This deal concludes a string of disposals that will have generated cash proceeds of £7.5bn in eight months.

Since taking charge in July 2020, Ms Blanc has sold businesses in Singapore, Indonesia, Hong Kong, Vietnam, France, Turkey, Italy and now Poland. Today’s sales concludes the “the planned refocus” of Aviva’s portfolio and leaves the business focused on its core UK, Ireland and Canada businesses.

Capital return: Shareholders are set to receive some of Aviva’s surplus cash.

The sale of the Polish business will add £1.5bn of excess capital to Aviva’s balance sheet and increase its regulatory Solvency II cover ratio by 13%. The insurer’s IFRS net asset value will rise by 46p to 539p.

Some of the cash from these disposals will be used to meet Aviva’s debt reduction targets. This involves cutting the group’s debt leverage ratio to under 30%. Leverage at the 2020 year end was reported to be 31%, so I think we can conclude that the company is making good progress in this regard.

Indeed, Ms Blanc confirmed today that good progress has been made with debt reduction and says that “in due course we will make a substantial return of capital to shareholders.”

What next? Ms Blanc has kept her promise to move at pace and rapidly slimmed down Aviva to focus on its three core geographies of UK, Ireland and Canada. These are markets where the company has good scale and market share.

However, I think it’s fair to say they’re also fairly mature markets. So the next test for the company will be to deliver a return to sustainable growth.

I suspect that Aviva’s lack of consistent growth is one reason why even after today’s news, the stock is trading at a discount of nearly 25% to its indicated NAV.

My view

Aviva shares offer a near-6% dividend yield at current levels and still looks reasonably priced to me. If nothing else I expect this unloved FTSE 100 stock to prove a reliable source of income over the next few years. I remain happy to hold.

Smiths Group

  • Stock data should display here.
Market cap £5.8bn
RNS Interim results
Writer disclosure No position

I suspect the new, slimmed-down Aviva will become the subject of rumours about corporate action. It could be both a takeover target and an acquirer.

Another company that’s regularly mooted as a break-up candidate is engineering group Smiths. This UK firm is in the process of separating its medical business, which makes a range of medical devices – including ventilators – and consumables that are used in hospitals and ambulances.

The company’s other businesses are Smiths Detection (airport security scanners and similar) and John Crane, Smiths Interconnect and Flex-Tek. These three firms make a wide range of parts and systems used in industrial sectors, such as energy, chemicals, and aerospace. Looking at this list, I’d guess Smiths Detection could also be an attractive standalone business.

Smiths is a stock that’s proved a good company to buy in the dips. Sadly I haven’t managed this yet. I don’t think I will after today’s interim results either, which have been well received by the market.

Results highlights: Today’s results show a fairly steady performance during the six months to 31 January. One attraction of this business is that it generates a significant proportion of revenue from aftermarket sales. These tend to be essential and funded from clients’ operational expenditure. This means they’re less likely to be cut during difficult times.

  • Revenue was down 7% to £1,150m
  • Operating profit (ex Smiths Medical) was down 1% at £143m
  • Basic earnings per share down 11% to 32.3p
  • Headline free cash flow up 71% to £188m
  • Interim dividend up 6% to 11.7p

The obvious outlier here is free cash flow. Why did cash conversion improve? Much of the increase seems to have been driven by favourable working capital movements. Inventories and receivables fell by a combined total of £123m. Excluding working capital movements, cash generation was fairly similar to last year.

Net debt: Smiths’ net debt was £1,075m at the end of the period, down £66m on the prior year. This equates to leverage of 1.8x EBITDA, or 5.8x times trailing 12-month net profits (my preferred measure).

Although I don’t think Smiths is likely to suffer any problems as a result of leverage, I would say that this is at the upper end of what I’d be comfortable with.

My view

Smiths remains an interesting business with some attractive elements. My sums suggest a TTM operating margin of 10% and a TTM return on capital employed of 5.5%. These don’t seem all that exciting at first glance, but the underlying profitability of the group’s individual businesses is generally in the low-teens. I think there should be scope for group profitability to improve.

This stock certainly seems priced for a positive outlook, trading on 19 times FY21 forecast earnings and around 17x FY22 earnings. I reckon that’s probably fair value at the moment, but I might be tempted at a lower level.

That’s all for today, thanks for your company this week — have a great weekend.




Wordpress (2)
  • comment-avatar

    Hi Roland, As a long term and recently increased holder of Aviva (debt and equity) thanks for this.

    • comment-avatar

      Thanks Laughton. I’m a fairly long-term holder of AV too. Although it’s not been a smooth ride, my shares have proved a good source of income. I’m hoping for a more stable and sustainable performance going forwards.

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