Should I buy shares in Aviva?

Shares in Aviva plunged 12% as the insurer announced a 27% cut in its 2012 dividend, as well as the elimination of its scrip dividend, to help pay down debts and build up its capital reserves.

"The rebasing of the dividend and the elimination of the dilutive scrip is about giving certainty to shareholders, reducing debt, and putting Aviva in a sound position for the future," commented chief executive Mark Wilson. "This is the right course of action."

Analysts agreed, saying the cut would help fund a turnaround strategy at the company, which has struggled with poor performance in recent years.

The announcement came as Aviva unveiled its full-year results, revealing a post-tax loss of £3 billion, driven principally by writedowns related to the sale of its US business, agreed last year.

"2012 was a year of transition at Aviva," Wilson commented. "There has been solid progress against the turnaround plan set out last year. Our capital strength has improved materially and we have completed the vast proportion of the disposal programme."

Since implementing a recovery plan last year, the insurance firm has indeed cut costs and raised more than £2 billion by offloading less-profitable businesses.

Wilson added: "We have made progress reducing costs and we also have a strong new management team in place."

The current chief executive joined Aviva in January after his predecessor, Andrew Moss, was forced to resign following a shareholder rebellion over pay and performance.

"Worst dividend-paying record"

"The 27% dividend cut makes Aviva's record the worst amongst major UK insurers this century," said Kevin Ryan, analyst at Investec. "Each of the last three chief executives has cut the dividend.

"Aviva has the worst dividend-paying record of all the major UK life companies and it will clearly take some considerable time to persuade investors that the latest management team have got it right this time."

He added: "The real disappointment is that unless something exceptional happens, Aviva will not regain the dividend level it used to pay in recent times."

As a result, Ryan was of the view that the dividend he forecast for 2013 was "too optimistic". He revised his prediction to an interim dividend cut of 44% to 5.6p, which would result in a 2013 full-year dividend of around 14.6p.

"The company claims that much of this has been necessitated by the complex corporate structure which is now being simplified into a single holding company and a series of operating subsidiaries. We view this as a poor excuse," he scoffed.

Removal of uncertainty "strengthens" investment case

Barrie Cornes, analyst at Panmure Gordon, agreed there would be pressure on the share price in the short term, but stressed the removal of dividend-related uncertainty would strengthen the investment case.

"Whilst many investors will be very disappointed, we also believe that this removes the potentially damaging uncertainty over a future potential cut," he said. "The saving will be used to restructure the business as it looks to lower internal and external debt."

"Snapping up" Aviva shares

John Truong, senior trader at Accendo Markets, was much more optimistic.

"A 15% move seems harsh and severely overdone," he stated. "At 19p, the dividend yield is still over 6% at these prices, I would be snapping up [the shares] for a bounce and the longer-term yield."

On a more fundamental basis, Credit Suisse was of the view that the impact of the restructuring programme on earnings mix was still underappreciated. Analysts at the broker predicted that from 2014, more than 70% of post-tax profits would be derived from the UK, Canada and Poland.

"In view of this, we believe Aviva will have a more attractive mix of earnings, which, together with balance sheet repair, should lower the cost of equity," it said.

Attractive valuation

Aviva trades at 2014 price/earnings (P/E) ratio of about seven times, at more than a 20% discount to the sector, which is trading on a P/E ratio of about nine times.

Interactive Investor view

Aviva's decision to cut the dividend was probably a tough decision for the new chief executive, who joined the company only two months ago.

The company has received £2 billion from its recent asset disposals and therefore could pay the dividend if it so wished.

However, the company has used proceeds from asset sales to fund the dividend for the past four years, and using asset sales to fund dividend payments is unsustainable.

Furthermore, it has been estimated that Aviva needs to use £1.5 billion of the proceeds to pay down debt due in the next 18 months, to reduce its debt leverage from about 50% at year-end 2012 to about 40% by 2014.

Additionally, if the insurer did not cut its dividend, the company would have had to keep talking about the sustainability of its dividends for the next 24 months, when the chief executive would prefer to talk about the progress he is making transforming the business and focusing on the next leg of the story.

As Wilson said: "Aviva has many strengths to build on. My intention is that Aviva will be a simpler business with a robust balance sheet that delivers sustainable cash flows and growth."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.