Interactive Investor

Upgrades for two FTSE 100 insurers with dividend yields above 9%

In a new research note on the UK insurance sector, this team of experts have upgraded some of the industry’s big names, but downgraded others. City writer Graeme Evans rounds up the key changes.

29th November 2023 13:46

Graeme Evans from interactive investor

Rotation from Aviva (LSE:AV.) to Legal & General Group (LSE:LGEN) and strong support for Direct Line Insurance Group (LSE:DLG) are among key developments after a City bank shuffled its recommendations today.

Deutsche Bank said Aviva had been the standout name in its coverage since 2020, fuelled by £5 billion of excess shareholder returns and the start of an annual share buyback programme.

However, it warns the shares could underperform in the event of further earnings pressure in Canadian personal and casualty lines or if buybacks do not exceed the consensus £300 million.

Other UK life peers have not engaged in returning excess capital, although since Sir Nigel Wilson became L&G CEO in June 2012, he has overseen an approximate 250% total return. 

His successor Antonio Simoes is likely to present a strategy update some time next year, a move that will coincide with the end of L&G’s current 5% dividend growth policy.

Deutsche Bank believes the group could lift the dividend faster than 5%, with any incremental growth adding to an already attractive 9.4% forward yield.

However, the largest potential positive catalyst is the likelihood that favourable estimates for solvency and excess capital leave L&G in a position for a share buyback in 2024.

Deutsche Bank reckons this could amount to a one-off distribution of £750 million, equivalent to 5.5% of market capitalisation and about 10 points of solvency. The solvency ratio stood at 224% in November even after record pension risk transfer volumes. 

The bank has a price target of 295p after switching its recommendation from “hold” to “buy” on both Legal & General and fellow FTSE 100 stock M&G Ordinary Shares (LSE:MNG), which it now values at 250p. 

M&G shares have outperformed UK life peers year-to-date but Deutsche Bank believes there’s scope for a gentle re-rating in the event of a sustained improvement in asset and wealth management flows and earnings.

If the group is successful in achieving a 30% debt leverage ratio by 2025, Deutsche Bank says management will have the option to use excess capital for other purposes including shareholder capital returns.

It sees each reporting period in 2024-25 as positive catalysts, while noting the appeal of a 10% dividend yield.

On Aviva, it is downgrading from “buy” to “hold” with a new price target of 285p. The bank said: “Whilst Aviva has been the best performer of the UK life names since mid-2020, we believe that the story may be running out of steam.”

It adds that Aviva’s slight valuation premium to UK life and continental insurance peers is becoming more difficult to justify.

The support for Direct Line Insurance comes with Deutsche Bank confident that the group is back on the right path and ready to reinstate its dividend with results in March.

The shares are up by a fifth in the past month but below where they were before the scrapping of 2022’s shareholder distribution due to the impact of cold weather claims.

Deutsche Bank believes margin expansion from above-market pricing and the potential for volume growth in 2024 should be supported by a refreshed strategy by the incoming CEO.

The shares are 20% below the historical average price/earnings (PE) multiple and about 55% below the 2025 projected PE for Admiral Group (LSE:ADM). Highlighting the considerable scope for a re-rating, the bank’s new price target of 250p offers 30% upside potential.

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