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Is the Aviva share price undervalued after dividend suspension?

Aviva and other UK insurers followed leading banks’ example by suspending dividend payments during the pandemic. This move caused Aviva’s share price to tumble.

Aviva Source: Bloomberg

The postponement of dividends has unsurprisingly been a theme as the spread of COVID-19 has accelerated in the UK. On 31 March, the UK's leading banks responded to advice from the Bank of England (BoE), suspending dividend payments to protect capital as the pandemic squeezes the national economy.

A week later, the UK's major insurers followed the lead of the likes of Barclays and HSBC. Alongside Direct Line, RSA, and Hiscox, Aviva opted to suspend dividends for this year.

Sam Woods, deputy governor of the BoE's Prudential Regulatory Authority, wrote a letter to the major insurers' chief executives on 31 March. In that letter, Woods emphasised insurers' responsibilities to 'protect policyholders' so firms can play a 'full part in supporting the real economy throughout the economic disruption' caused by the pandemic.

Immediate effect on Aviva share price but long-term outlook remains unclear

While it may be a sure-fire way to reduce the value of shares, pressure from high places and possible negative publicity drove insurers to view dividend suspension as the sensible choice.

The banks' decision to suspend on 1 April caused the share price of UK insurers to fall, with investors perhaps pre-empting that industries with exposure to financial markets would have to follow suit.

Aviva was due to pay out £839.4 million in June, accounting for around 65% of the £1.3 billion shareholder payments suspended by the four companies. Subsequently, Aviva share prices were hit the hardest of that quartet of major UK insurers.

Direct Line and RSA posted drops around the 5% mark, while Hiscox shed under 1% in value. Aviva shares dropped by 8.6% after the news about the banks broke, although short-term declines will have been anticipated by executives.

Once the four insurers confirmed their position on dividends on 8 April, the Aviva share price did not fall as sharply as the week before. This time, Aviva shares shed around 5% of their value, recovering much of that loss in the next day of trading.

L&G lagging in dividend suspension, with possible ramifications for Aviva

The biggest concern for Aviva executives going forward will be if the suspension of dividends affects the position of existing and prospective shareholders. Charles Bendit, a market analyst with Redburn, indicated that the postponement could have 'material long-term consequences for the make-up of its shareholder register'.

This could undermine the potential for Aviva's share price to post long-term growth. The case of Legal & General (L&G) will be instrumental in determining if Aviva and other insurers will suffer from a lack of commitment to shareholders.

L&G has thus far withstood the calls to suspend dividends. L&G's 3 April announcement to distribute £750 million to shareholders defied the pleas of the BoE, while the insurer also chose not to fall in line when Aviva and others made the decision to postpone. If L&G reneges on this choice, then the early clarity provided by Aviva will stand out as an intelligent move. If L&G can honour stakeholder payments and successfully manage operations during the pandemic, then investors in Aviva will inevitably have questions about the company's strategy.

For now, Aviva shares appear to have shaken off the malaise caused by both the FTSE 100 crash and the dividend suspensions. Following the Easter weekend, Aviva opened trading at 265p, an encouraging turnaround from a share price value of 211p on 23 March.

Aviva released a statement following the dividend announcement, reassuring stakeholders that the company 'remains well capitalised with strong liquidity'. The retention of the final dividend is estimated to increase the group's capital ratio by around 7% to a level of 182%.

The operations of Aviva do not appear to be under immediate threat by the circumstances created by pandemic, although a further operational update will be presented to investors in late May.

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Alternatively, invest in Aviva shares with share trading. You can buy UK stocks for £3 commission if you have traded three or more times in the previous month. Otherwise it’s just £8.

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