The Aviva (LSE: AV) share price has surged over the past 12 months. Over the past year, shares in the financial services giant have added nearly 34%, excluding dividends. Over the same time frame, the FTSE 100 has returned just 13%, excluding dividends.
But even after this impressive performance, I still think the stock appears undervalued.
Aviva share price performance
During the past year, Aviva has been overhauling its business model. It’s agreed to sell eight non-core divisions, raising almost £8bn. These sales have undone much of the work completed by the former management, which wanted to take the group into new markets around the world.
Under the leadership of its new CEO Amanda Blanc, the company is focusing on its core British, Irish and Canadian markets.
Blanc has also promised more deals and investment in the years ahead. A core part of Aviva’s strategy has been to move away from life insurance, which can be a tough business.
Life insurance challenges
Life insurance companies have some unique challenges. They have to manage assets and liabilities with precision to make sure policyholders can claim payouts over a multi-decade horizon. This is challenging because no one knows what will happen over the next few months, not to mention the next few decades.
Even a slight change in interest rates could have a considerable impact on life insurers’ profits and balance sheets. The company’s exposure to this challenging market may be one reason why investors have avoided the Aviva share price in the past.
By comparison, non-life business tends to have a much shorter lead time. Car insurance is a great example. Customers pay a policy every year, and the insurer knows it may have to pay out in that year. If not, it can keep the cash.
Less than a quarter of Aviva’s business is currently non-life, and management wants to increase its share of this more lucrative market. Some analysts have speculated that the company could use some of its newfound cash to buy up other UK insurers. That’s a possibility, but nothing has been announced yet.
Strategy risks
Of course, this strategy comes with risks. Aviva could be stepping out of its comfort zone, and this may lead to group losses. It could also end up alienating existing customers, which is something any corporation that relies on repeat business wants to avoid. If profits come under pressure for either of the above reasons, Aviva may have to re-think its growth plans.
Still, I am encouraged by the firm’s recent progress, as well as the company’s hefty dividend yield. The Aviva share price currently supports a dividend yield of 6.9%, although this isn’t set in stone. If any of the risks outlined above materialise, management may have to reduce the payout.
The stock is also selling at what I believe to be an attractive forward price-to-earnings (P/E) multiple of 7.2. Considering the firm’s potential, I reckon this severely undervalues the business.
