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RBC upgrades Brexit-proofed Aviva as it downgrades SLA

RBC upgrades Brexit-proofed Aviva as it downgrades SLA

RBC Capital Markets has upgraded Aviva and downgraded Standard Life Aberdeen (SLA), despite the former being without a chief executive.

The bank said that, even with uncertain leadership, now is the time to buy Aviva, as it sees no reason for a new CEO to change the dividend policy.

‘With such a strong balance sheet, and our belief that the new CEO will be appointed from the existing board we believe the current dividend policy is safe,’ said RBC analysts Gordon Aitken and Kamran Hossain.

In stark contrast, the pair sees that SLA’s dividends are less secure, a situation that is made all the worst by a shrinking asset base. They exepct the company's client funds will fall 9.4% by the end of 2020.

SLA's interim results reported dividend cover from continuing operations of just above one times.

‘Falls in financial markets have exacerbated the issue. At this rate, the current dividend policy will come under pressure, in our view,’ said Aitken and Hossain.

Adding more fuel to the fire, RBC calculated outflows from SLA's misfiring GARS range accelerated in November, with around £2.7 billion exiting, bringing 2018 total outflows to £12.6 billion. 

‘We expect outflows to continue and adjust our 2018 net outflow forecast for GARS to £15 billion (from £12 billion). We maintain our net outflow forecasts of £7 billion for 2019 and £5 billion for 2020.’

Is Aviva safe from Brexit?

‘Aviva should be less impacted by Brexit than its peers,’ the analysts at the bank noted. Since May 2018, UK life insurers’ shares have fallen by 39.2%, with Aviva’s share price down 35.5%.

‘The share price, in our view, however, reflects history rather than the current reality: it reflects the fact that the group’s [Aviva] balance sheet was weak (prior to the Friends Life acquisition) and that dividends were cut several times.

‘We firmly believe the current position is materially different to history and there is no requirement to change the dividend policy.’

Despite Brexit weighing on the sector the duo point to Aviva’s higher proportion of non-UK revenue than the average at 46% vs 23%, as well as, its lower proportion of life revenue (76%) relative to Prudential, Phoenix and Just Group, as a safeguard.

‘We would expect that UK life insurers with higher proportions of UK revenues, more spread products and weaker balance sheets would be the most impacted by Brexit, and therefore have the worst performing share prices. However, what we are seeing is the sell-off has occurred across all stocks in the sector,’ Aitken and Hossain said.

They added that they see Aviva's current dividend yield of 8.9% as secure in any Brexit scenario or CEO appointment.

However, SLA’s sale of its life insurance business to Phoenix this year leaves the company’s dividend more vulnerable as it relies solely on the cash generated from its asset management activities—revenues from which are subject to market conditions.

They added that the life insurance business was sold too cheaply: ‘We believe SLA sold its life insurance business at a 21% or £8oo million discount to what it is worth, based on our calculation of its embedded value (£2.9 billion versus our estimate of £3.7 billion).’

Also, following the sale, SLA’s capital requirements will no longer be set under Solvency II rules – which applies to insurers and this increased confidence in their dividends since its introduction in 2016.

The change means the insurer needs to show the regulator it will be able to meet its capital obligations over the next year with 99.5% likelihood.

Instead, it will fall under the Capital Requirements Directive IV, the European regulatory capital regime that applies to investment firms.

In contrast, the Aitken and Hossain noted, Aviva is covered by Solvency II capital requirements.

‘We are comfortable with Aviva having a 187% coverage of its Solvency II capital requirements and expect it will generate sufficient cash each year to cover its increasing dividend irrespective of whichever form Brexit takes.’

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