Date: Wednesday 27 Jun 2012
Shares of insurance giant Aviva were advancing on Wednesday morning with the stock shrugging off a downgrade by Jefferies from 'buy' to 'hold'.
"Reversing the current valuation discount requires a significant increase in economic capital given further deterioration in Q2," the broker said in a research note on Wednesday morning.
It estimates economic capital adequacy to be 135% in the second quarter, down from 145-150% in the first quarter due to lower equity market, wider credit spreads and higher Spanish/Italian bond yields relative to euro swaps: "Aviva now screens as the weakest capitalised of the European insurers but also with the most volatility. Our stress test shows this could easily fall to 100% (calibrated to BBB) if Eurozone concerns deteriorate. This would be untenable in our view."
The stock currently trades at a 60% discount to its peers due to these concerns over capital.
"We think that a level of 170% would be appropriate (from 135% currently) given structurally high volatility. Our analysis suggests that plugging the implied £3.2bn equity gap would not be value accretive."
Jefferies has previously argued that disposals at Aviva could be the catalyst to reverse the recent underperformance but says that the current environment makes this very difficult. "We also think that new management remains committed to the composite model, arguing against a possible sale of more marketable assets."
The broker has cut its target price for the stock by 27% from 386p to 281p. With only 7% upside to the current share price, the rating has been cut.
Nevertheless, shares were trading 0.65% higher at 263.4p by 10:50.
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