Prudential: Growth with or without Brexit

The Prudential (PRU) at 1,309p.The chart is still trending down but the shares look good value on an estimated prospective annual dividend yield of 3.5 per cent and prospective PER of 10.2 times for next year. The dividend has grown at 10 per cent over the last five financial years and estimated growth this year and next continues in that spirit. This company does not need a Brexit to grow outside Europe.

The Prudential Corporation (PRU) has, like mining stocks, been one of the ways into Asian growth prospects. Unlike them, however, the Prudential has a longer-term, less cyclical, involvement with living standards in the region generally and particularly with developing needs for savings and pension products. It is thus, a company and business that has a continuing and growing role in the Asian Pacific as nations grow their consumer and middle classes, and gradually move away from pure exporting and infrastructure activities to more broadly based domestic ones. To that extent, therefore, the Prudential remains a means of investing in these prospects which differentiates it in principle from the mining stocks which, as stated above, will be more cyclical.

At this stage, the Prudential has growing business interests in Indonesia, Hong Kong, Malaysia, Singapore and China (by means of a joint venture). Its other areas of business interest are in America and of course the UK which, although now much smaller, is still significant and in recent times a generator of the cash in a mature and competitive market, for the investment in Far Eastern pensions, savings and investment markets.

Digging around in the labyrinth of last year’s accounts (the year to December 31^st 2015) it was reported that just over 50 per cent of annual premiums (APE) originated in Asia, 31 per cent in America and some 18 per cent in the UK. America was the biggest generator of total group long-term business having contributed a reported 42 per cent of the firm’s £4,067 million operating profit. Asia contributed 30 per cent and the UK the balance. On the face of it, therefore, the scope of further long-term growth for the Prudential in Asia would seem to lie both in increasing sales and rising operating margins. As a ‘Brexit’ debate observation, the Prudential has done this as a UK company operating from within the EU. Consequently, it does not require an exit from the EU to expand and flourish in markets in Asia as a financial services company. That is a matter of empirical observation. The Pru is Berxit neutral in that respect.

History…

The shares have not broken out from the downtrend that began in early 2015, when the share price peaked somewhere just below 1,750p. This is to the benefit of the current dividend yield, taking away much of the previous premium demanded by the market from investors in an attractive FTSE100 growth situation. At a share price of 1,309p (last seen) the historic annual dividend based on the 2015 payment, is just a smidgen under 3 per cent. On the face of it, pretty enticing for a company that has reportedly, over the last five years, grown earnings and dividends by over 12 per cent and 10 per cent p.a. respectively. This is particularly so given that the company appears to have a strong balance sheet with surplus funds to more than cover liabilities (based on the last annual report annual report and accounts). The consensus of analyst estimates suggests that there is discernible estimated growth in dividends and earnings ahead.

Prospects…

This year, those consensus estimates are for a 7 per cent decline in underlying earnings per share to 116.7p but a contrasting 7 per cent increase in annual dividend payout to an estimated 41.6p. The management recently stated that its progressive annual dividend payments would be related to a dividend cover policy of two times dividend cover. The historic cover for last year’s annual dividend was 3.2 times. On this year’s aforementioned estimate, it is 2.8 times, despite the estimated 7 per cent decline in earnings per share. I add that the consensus estimate is for a 9 per cent recovery in earnings in 2017 to 127.5p which, after a payment increase of near 10 per cent in the annual dividend, to a consensus forecast 45.8p, will on that basis be covered about 2.8 times.

Dividends…

My interpretation of the Prudential’s dividend policy is that dividends will be increased until and if the cover moves below two times. Clearly, it is expected to be covered by a number well above that level for this year and next. I further understand that the company is probably retaining the higher annual dividend cover of 2.8 (rather than reducing it to two times) because it still wishes to invest in the business’s continuing growth overseas – something which is beneficial to rising future earnings and dividends. Although, for the moment, a dividend cover of only two times is not envisaged, it interesting to know that a two times cover on this year’s (year to December 2016) estimated earnings per share figure of 117p would imply a notional annual dividend of 58.5p and a notional annual dividend yield of near 4.5% on a share price (last seen) of 1,309p. It is to be noted that surplus funds were last distributed to shareholders by way of a special dividend – a policy which I assume will continue as and when funds within the company come into surplus. In short, there is reason to regard forecast estimated earnings and dividend figures, if achieved, to understate dividend returns from Prudential shares when funds are in surplus.

The company is well capitalised in relation to regulatory requirements and exigencies of the commercial necessity. At the end of last year, the company had surplus capital in its balance sheet of £5.5 billion. It reported that this amount covered liabilities 2.5 times.