Aviva is a stock for all seasons

Predicting the future is fraught with difficulty. Even during the most genteel of trading conditions, risks can come along which even the most pessimistic, doom-mongering of investors didn’t see coming. Given the uncertainties facing investors at the moment, I think it’s even more challenging than ever to guess which way the market is going to go.

For example, there could be more to come from the Trump rally, or his policy action could lead to a ‘risk-off’ attitude. Brexit could be a great thing and release the UK from the shackles of the slow-moving EU. Or, it could leave the UK isolated and without access to the key single market. The pound could slump yet further, inflation could move to its highest level in a decade and interest rates could respond by beginning the long road to normality.

Any (and many) of these things could take place this year. Therefore, I think a sensible option is to buy companies which could be stocks for all seasons. In my opinion, life insurer Aviva (LON:AV.) offers growth prospects due partly to its merger with Friends Life, an appealing valuation in case the market falls and an enviable dividend outlook to protect against higher inflation.

Income appeal

I believe inflation is only heading in one direction in 2017 – up. I may be wrong, but the trend is showing a gradual rise, with inflation now 1.3 percentage points higher than it was prior to the referendum in June last year. I don’t think the full extent of sterling’s devaluation has yet filtered through into prices, since retailers may have chosen to absorb some of their higher input costs in order to sustain LFL sales. Therefore, I think sterling’s near-20% depreciation in the last eight months will cause inflation to rise to at least The Bank of England’s forecast of 2.7% this year.


Given this scenario, dividend yields may become more important. Yields may no longer be measured in absolute terms, but in relative terms compared to inflation. Therefore, I believe Aviva’s 5.2% yield could make it a useful share to own this year. Its dividend payout ratio of 52% may now be roughly in line with a target dividend payout of around 50%, but with synergies yet to come from the merger with Friends Life I think dividend growth will easily outpace inflation this year and next. This will provide a ‘double’ inflation-beating income scenario, with Aviva’s yield and dividend growth likely to remain ahead of inflation. I doubt there will be a long list of large-caps able to offer this in 2017 and 2018.

Growth prospects

After the referendum, Aviva was quick to react to anti-Brexit sentiment among investors. It stated a restructure would not be required and Brexit would not have a significant operational impact on its business. It pointed out the health of the company via capital ratios such as a solvency ratio of 174%, as well as pledging to increase its dividend payout ratio to 50%. Therefore, even if Brexit talks between the EU and UK break down this year, Aviva’s growth outlook may not be harmed as much as some investors currently believe.

The company recently announced a restructuring which will see it enter a new phase in its transformation. It now has a stronger balance sheet and can invest for future growth. It is likely to benefit from synergies created by the acquisition of Friends Life, while the merging of its life, general and health insurance businesses in the UK could mean greater efficiency and lower costs.

…Aviva has solid growth prospects whether Brexit proves to be a good or bad thing for the UK economy.

The company’s international operations also offer growth prospects, in my opinion, even though they are now narrower than they were a few years ago. They could perform better than expected due to forex gains over the medium term, and since 42% of profit is generated outside of the UK this impact could be relatively large.

In my view, Aviva has solid growth prospects whether Brexit proves to be a good or bad thing for the UK economy. Its international exposure, financial strength, the prospect of efficiencies from the Friends Life deal and the merger of its three UK insurance businesses mean its growth outlook is sound in my opinion.

Valuation

Given the uncertainty brought about by Brexit and Donald Trump’s election win, I think investors should demand a relatively wide margin of safety before buying shares. As mentioned, the world economy could have a fantastic 2017. Stock markets could continue the Trump rally and Brexit talks may pass without a hiccup. However, in my opinion there are risks from those two events which need to be accounted for in valuations. This year really could go either way, with large gains or losses very possible.


Aviva’s valuation gives me a degree of confidence in its outlook. It has a P/E of 11.4, which I feel represents good value for money given its EPS forecasts. By the end of FY2018, its EPS is forecast to be 19.2% higher than it was in FY2016. Although this growth outlook is subject to change and could be marked down if the economic situation declines, it could equally be bolstered by forex gains resulting from weak sterling. Therefore, I think Aviva has merit as an investment on valuation grounds, since it offers a margin of safety given the risks facing UK investors.

Outlook

Forecasting what will happen in any given year is always tough. However, this year it feels more difficult than it has done for many years. The list of risks facing investors is long, with Donald Trump’s policies and Brexit being the main ones. They could cause weaker sterling, higher inflation, falling share prices. Or, they could have quite the opposite effect.

Therefore, I believe covering as many bases as possible when investing could be a good idea in 2017. In my view, Aviva does just that. It offers a high yield and high dividend growth rate. Its restructuring could create efficiencies, while its international operations and financial strength offer growth potential. Its valuation is undemanding, in my opinion, which could lead to an outperformance of many of its stock market peers. Overall, I think Aviva is a stock for all seasons and could be a top performer this year.