Description

AvivaSA is a capital light insurance & pension franchise with a long run-way for growth available at 10X earnings while generating 35% ROE ! Good management execution and strong market position !

Disclaimer: We own around 1.2% of the firm and hence my views are very biased. I might have made some genuine mistakes in my analysis and request members to do their own calculations. I have used information and images from AvivaSA, Anadolu Hayat and AkBank investor reports and other sell side reports. We have not bought or sold shares in the last 30 days.

AvivaSA – Attractive Franchise with growth!

AvivaSA is Turkey's leading Pension and insurance firm. While Aviva Plc (40% shareholder) brings its global insurance expertise, the Sabanci Group (40% shareholder) which is one of Turkey's largest conglomerates brings with it the Akbank relationship which provides AvivaSA a huge distribution edge in the marketplace along with embedded digital capabilities.

AvivaSA’s pension business is a capital light asset management business with no underwriting or balance sheet investment risk. It generates strong predictable fee income, and the firm has grown its pension AUM at 26% CAGR over the last 5 years. Similarly, Avivasa's insurance business does not underwrite complex risks and is primarily an origination or a trust based selling business. It has grown GWP's (gross written premium) at 42% CAGR over the last 5 years as the firm got strong customer traction on its credit linked insurance and long-term dollar saving products. The firm is very well run with the best in class ROE's of 35% and a total dividend pay-out ratio of 50% to 75%.

The insurance and pension penetration in Turkey is very low and the firm has a long runway to grow both its business segments for the next several years. In emerging markets with high interest rates like Turkey, it is extremely valuable to have a profitable long tail liability franchise especially when the only underwriting metric that they need to get right on the risk side is mortality rate which is relatively non-volatile. AvivaSA is an interesting way to play the increasing financialization story without the underlying credit or balance risks that come associated with it.

The current market cap to flow earnings (potential lifetime profits from products sold in 2019 alone) is only 5.5X. The stock is trading at around 1.2X embedded value (crudely analogous to book value) and 10X IFRS earnings. The primary risk in our thesis continues to be the worries around Turkey's macro economy and the potential currency depreciation.

Business Segments:

Two year back, the mix used between the pension and life protection business used to be 45%: 55%. The life protection business has grown substantially faster than the pension business and hence the change in business mix. If you add investment income (33% of total profits) which is majorly a contribution of the AUM from protection business, it is clear that this segment is the most important to our analysis.

IRR’s and Paybacks in the pension business does not truly reflect the long-term profit potential (money multiple) and the client stickiness that this business generates. Similarly, the Life protection segments IRR and Payback calculation is very high because of the short tenure of these products.

The pension business is attractive from the client stickiness perspective and also as a pure fee-based asset management business. The Life Insurance business has much higher front-loaded profits than the Pension business and is a direct beneficiary of the low insurance penetration rate in the country. In a high interest rate country like Turkey, it is an extremely valuable to have a profitable long tail liability franchise especially when the only underwriting metric that they need to get right is mortality rate which is non-volatile and hence no complex underwriting for underlying risks.

On a broad basis, AvivaSA has increased market share across its protection segments by 2% from approximately 6% to 8% over the last two to three years. They plan to increase their market share further to 10% in the next 3 years.

Distribution Strength:

In emerging markets, banks overtime have built a strong trust with customers to manage their money. Hence, most of the other financial service products like insurance, asset management, pension, wealth management, broking etc are sold better by banks. The customer relationship, data, brand and distribution give subsidiaries promoted by banks a huge first-mover advantage in the marketplace. Hence most of the good non-credit financial franchises in emerging markets tend to be bank subsidiaries. For example, AkBank’s brokerage division AK Yatrim has a corporate bond issuance market share of 34% and its asset and wealth management divisions have a 15%+ market share.

AvivaSA also has the largest direct selling agent team in Turkey along with strong tele-sales and corporate distribution channels. The break-up of the distribution between bank channel is 59% and direct channels is 31%. If you remove the credit linked insurance segment which is wholly a bancassurance product, the distribution mix is 53.5% through direct channels and 46.5% through the AkBank distribution channel.

AvivaSA has also been increasing its investment in digital platforms. On the digital side, Avivasa has been experimenting with newer concepts like Bidolu which is a shopping platform for its customers. As pension is a very sticky product with monthly contributions and regular management by clients, the distribution platform can use its captive customers for regular cross-sell. Despite strong investments in digital channels, AvivaSA has been focused on managing costs well.

AkBank has also been digitally savvy with strong customer acquisition and servicing its young customer base through digital channel. It’s AkBank lab is collaborating with over 100 international fintech’s and has built a strong user base for its mobile app.

Life Protection – Credit Linked Insurance segment:

Credit linked insurance is a simple life insurance product that is attached with personal loans. So whenever someone borrows money for mortgage or personal loans or car loans, the life insurance pays off the loan in case the borrower dies. This is basically an origination business that grows with the support of bancassurance distribution channel. AvivaSA's biggest advantage in this business segment is its parent bank - Ak Bank.

This is primarily a single premium product that is sold at disbursal and is amortised over the life of the loan for the borrower. This is the most profitable product at AvivaSA and the most sensitive to macro-economic conditions. After the initial sale commission that gets shared with the bank distributor, the product breaks even within a 3 to 5 month period. The credit linked business is directly linked to the fresh loan disbursal and hence most impacted during the COVID phase. There is no stock/ back book that builds continuous cash flows for the future years, but from an IFRS standpoint, both the revenues and expenses are deferred over the loan duration (average term is 36 months).

The way I think about this business segment is that it is a direct and low risk way of playing the increasing retail credit in Turkey as almost 70 to 80% of all retail loans at Ak Bank are sold with AvivaSA's life insurance for a 20% premium income commission fee. The Life Insurance business has much higher front-loaded profits than the Pension business and is a direct beneficiary of the low insurance penetration rate in the country. The parent bank currently has a 18.2 Million customer base (growing at 5%/ year) and out of which 5.5 Million people are regular mobile app users. While AvivaSA itself has a large mobile app user base, its insurance products are seamlessly embedded within the parent banking app and serves as a good distribution channel. The bank gets paid fair distribution fee income for its origination, but the common promoter ownership means that they are able to work together more closely than peers who don't have this advantage.

Life Protection – Dollar ROP Savings segment:

Dollar ROP (return of premium) product is primarily a long-term savings plan. It has lower margins than Credit linked insurance but is the fastest growing product within AvivaSA. On a simplistic basis, this is a savings product combined with life insurance cover. It is a 12-year duration product and hence provides tremendous stability to the firm's earnings power base.

As an example, a customer usually saves 100 USD/ month for 12 years and at the end of the term, he receives back 12,000 USD. During these 12 years, he is provided a life insurance cover of 75,000 USD. The firm doesn't take any Forex risks and just simply invests in long dated dollar currency bonds to match this liability. The distributor gets approximately 1.5 months of savings as commission and the cost is getting amortized in IFRS results and upfronted in the SFRS results.

Since there are penalties to exiting this savings plan, they have a very high 95%+ persistence ratio. AvivaSA currently has around 180 Million USD+ of savings in force in this product. This business continues to grow in scale with an acceleration during large Lira depreciation periods. Local people look at this as an inflation hedged savings product that comes with a life insurance cover and hence the sale of this product increases during currency depreciation phases.

These long tenure savings or investment products with an insurance cover are just way a for people to create a forced regular savings plan that also provides some tax incentives. As pension funds or other long-term assets aren’t available in these markets, the insurance firms are able to match these long-term liabilities by investing in attractive long term assets at healthy rates. The decrease in long-term dollar interest rates puts pressure on the investment income of AvivaSA from this product.

Pension Business:

Turkey's pension business is very well regulated and provides enough incentives for salaried employees to build a pension corpus through monthly savings during their entire working age. The government provides a savings subsidy (25%) and also there are additional tax compounding benefits of savings under the pension scheme. The pension operator business is a very attractive business case as you do not take any underlying investment risk and only keep skimming asset management fee continuously for multiple years.

In an ideal world, once you get a client, he will keep saving with you for 25+ years (throughout his working age) with new assets coming into your fold every month (hopefully growing as he keeps moving up the experience curve of the corporate world). The government and regulators are focused on building a good pool of long term savings through this pension model and have aggressively promoted auto-enrolment (default for all companies with over 50 employees) in the market for universal working population coverage with an opt-out feature.

With the recent economic turmoil in Turkey and high inflation rates, there has been huge churn in the pension business. AvivaSA management has been saying that the government is looking at boosting persistency ratios in the next 2-3 years with more benefits for saving through the pension route. The pension business is attractive from the client stickiness perspective and also as a pure fee-based asset management business. The Pension Funds/ GDP is only 3% in Turkey and has a multi decade growth runway. Growth comes from new clients, new money from existing clients and AUM returns.

From a business point of view, a pension plan operator needs to give its customers multiple fund options for them to manage their pension savings. So the asset management funds should be outsourced to a 3rd party and have clear regulations for the fees chargeable in these structures. As of now, AvivaSA is able to charge 1.09% for credit/ money market/ liquid/ gold funds etc and around 2.28% for equity funds. They provide around 10% of these fees (10 bps & 23 bps) for the debt and equity fund management firms respectively. For the auto-enrolment option, the fees chargeable is low when compared with private voluntary pension schemes. The pension operators are also allowed to charge a entry and exit management fee. I believe overtime, there will be regulatory pressure on these yields, but the AUM's will continue to grow at a high pace.

Since Pension is a 10 year+ product and is very sticky with monthly contributions, it is a very good sourcing channel for the firm to cross-sell other financial services. AvivaSA's mobile application 'Fonpro' makes it easy for customers to toggle their money between various funds on the click of a button.

As of now, the equity funds is only 13% of the overall assets under management. There has been a shift towards risk-off funds like liquid funds which is pulling down the overall fund management fees. This has led to a drag in the fund fees growth when compared with the 35% CAGR in terms of AUM. Net new money as % of the existing stock of funds last year was around 5-6%. Lapse rates at pension plans have come down meaningfully in the last two quarters to less than 1% per month, but I believe the churn rates will increase with more macro uncertainties. An average pension fund customer with a normal mix of debt: equity has continuously outperformed inflation and other investment/ savings avenues in the country over the last 5-10 years.

Risks:

The risk in this investment continues to be the Turkish Lira depreciation and also the general macro environment of the country. To some extent - the dollar ROP business, pension business & investment income are impacted positively by the Turkish currency depreciation, as interest rates usually are high in such a scenario. This is the reason business continued to do well during the 2018 currency crisis. Turkey is hated and is rightly perceived as higher risk for investors. Hope is that a lot of the currency depreciation is already behind us.

There is a listed competitor in Anadolu Hayat Emekilik which has IsBank as its parent. I have met both the companies in Istanbul and felt that AvivaSA was better in terms of disclosures and management execution.

Risks are clear that the insurance and pension industry can never really become large if the country continues to run high inflation for the next decade as this creates disincentives for long term savings.

Avivasa's management has looked at inorganic growth in the past, but they felt that it is a distraction and hence focused on building the business on an organic basis. Any bad capital allocation would be a big risk.

Valuation Metrics:

The business continues to be very capital light and hence the firm continues to pay out 50% to 75% of the profits as dividends despite growing at a rapid rate. I like to think of the business in terms of stock (back book) and flow (front book). The ROP and Pension business provides significant visibility into future earnings of the firm as a policy sold today provides profits for the next several years. I believe that the stock of earnings will continue to build and compound while the flow of assets will be volatile but with a long-term upward trajectory.

The last few years, there has been negative assumption and experience changes in the pension and ROP business as the persistency ratios have moved all over the place as the business evolves at a rapid pace, making it difficult to use MCEV metrics for valuation purposes. I would value all these 3 different units in different ways, ROP business & Pension business using the Embedded Value metrics (primarily 'Value in Force' metric for stock potential and 'Value of New Business' for flow potential) and the Life Protection business on the segment IFRS profits.

The duration difference between their two main product segments makes it difficult to use any one particular metric for our valuation tool. The 'Value In Force' (stock earnings) is dominated by the pension business with almost 60% contribution while the flow earnings (VNB) is dominated by life protection business with pension contribution just being 11%. The value of new business written in 2019 was very high at 422 Million Lira's. This VNB is equivalent to 21% of the total embedded value (crudely implying that the flow is 21% of the stock). The current market cap to flow earnings (potential lifetime profits from products sold in 2019 alone) is only 5.5X. On an overall basis, the closest approximation of stock earnings is MCEV and flow earnings is IFRS profits (this is the easiest for us to track). As of today, the stock is trading at 1.2X embedded value (crudely analogous to book value) and 10X IFRS earnings.

Simplifying the investment case, I believe that while we are paying for the existing book, I do believe that the robust operational platform that will help to write more business consistently for the next decade is available to us for free at around current valuations.

I believe that a growth franchise like AvivaSA is available at attractive valuations primarily because of these macro-economic risks. In India (my home market), the good insurance franchises which have the backing of top banks trade at the following valuations,

The Indian peers have primarily life protection and savings products with no pension management business. AvivaSA’s life protection, personal accident and Pension business have a VNB margin of 18.2%, 21.7% and 1.2% respectively. It’s Price/ Embedded Value is approximately 1.2X and Price/ VNB is approximately 5.5X. Some of these numbers aren’t directly comparable as the Embedded Value split of AvivaSA is in the ratio of 2: 1 and hence it forms a disproportionate share of Embedded Value. Because of the mix of the pension business and the life protection business, there is no single metric that is best placed to value the business.

On the traditional metrics of Price/ Book and Price/ Earnings, AvivaSA is trading at 3X and 10X respectively. For a business that generates 38% ROE and has grown at 25%+ with increasing dividend pay-outs, I believe that these valuations are attractive.

Final Summary:

Emerging markets assets have massively underperformed the US equities over the last decade. The sentiment and fund flows continue to be negative. Turkey specifically has several macroeconomic and geo political issues that are for real and their currency is too volatile with a structural downward bias. In such a scenario, despite the underlying franchise being extremely attractive, an investor should always manage risk through appropriate position sizing and holding tenure.

You can buy such wonderful franchises only during a bad phase as only then you will find liquidity in these low float stocks and also the valuations tend to be reasonable. As you can look at the market share numbers, it is clear that AvivaSA has improved its market share across segments by focusing on the profitable customer segments. My investment philosophy is highly tilted towards buying market share gaining franchises as that is the best indication of the management efficiency and it also means that the business can grow by eating someone else’s lunch even during the bad market phases.

I believe that massive shareholder value would be created over the next 10 to 15 years in AvivaSA and a patient investor who is able to ride through the macro economic and currency volatility will be more than compensated for the risk. We need to continuously track the management’s execution on improving the franchise value.

Catalyst

Earnings Acceleration, Improved market share