Aviva shares have been favoured over Legal & General after a City bank took a closer look at what to expect from the UK insurance pair’s half-year results next week.
UBS sees a potential 25% upside for Aviva (LSE:AV.) to 480p, adding that its preference over Legal & General (LSE:LGEN) is also caused by lower exposure to market risks and its greater diversification.
The City bank likes L&G but has a “neutral” recommendation based on a 235p target price.
L&G is the first to report on Tuesday, with UBS not ruling out a surprise one-off buyback of shares given the company’s solvency ratio position.
It believes a sum of £400 million is affordable, although with a new chief executive starting next year and reinvestment opportunities likely to generate better returns the probability of such a move is regarded as low.
The half-year results season will be the first under the IFRS17 reporting standard, which changes the timing of profit recognition but has no bearing on solvency or cash flow metrics.
UBS expects the switch to cause a 30% reduction in earnings per share, a move that has heightened investor concern about dividend cover.
The sustainability of payouts and uncertainty over the UK economic outlook have meant that UK-listed life insurers have underperformed EU counterparts and the wider market this year.
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Aviva shares have fallen by about 14% and L&G is down 9%, with both stocks trading with projected dividend yields above 9%.
UBS expects Aviva’s results next Wednesday to include a 6% improvement in half-year dividend to 10.9p a share but with no share buyback. Operating profits are likely to be broadly flat at about £653 million, in line with the company’s guidance for around £700 million.
Areas to watch in the results include the potential impact of wildfires in Canada, particularly in Ontario where the company has a top three position in both commercial and personal lines general insurance.
UBS adds that Aviva's five-year earnings annual growth rate of 7.1% and retained earnings of £5 billion should be sufficient to alleviate investor concerns about the sustainability of the dividend.
Meanwhile, L&G’s projected earnings growth rate of 8.7% under IFRS17 also comes in higher than UBS’s dividend per share expectations for 5% a year growth to 2027.
Price/earnings (P/E) multiples for both companies are higher under IFRS 17, but with Aviva still screening cheaper than L&G. UBS said: “Aviva's P/E discount is unjustified given its diversified business model and lower exposure to market risks relative to L&G.”
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