Value opportunity in Prudential
The Prudential Corporation (PRU), 1,277p last seen, has a growing long-term global life assurance business with its largest contribution to premium income and profits coming from the Far East and the US. With the Far East under a Chinese black cloud, the previously highly rated shares have taken a relative and absolute tumble. It looks well placed to benefit from China’s long term move towards more personal consumption and Vietnam’s continued economic development on similar lines. The shares now look good value.
What does yesterday’s eight per cent fall in the prudential share price to 1,217p teach us? It is surely the old market wisdom that high ratings brook no disappointment. The rapid shrinking of the share price has all the hallmarks of a mark down on bad news, probably in the midst of a large sell order. Was somebody attempting to execute an overlarge ‘sell’ order? It is normally oil and mining companies that demonstrate this kind of price weakness – not dreary, slow moving, actuarially-driven life assurance and pension stocks like the Prudential.
Not, of course, that the Prudential has actually been dreary or slow moving over recent years, as it cut into the bamboo thicket of market share growth in the Far East. The Pru’s Asian market contributed approximately 48% of the embedded value in the first half of the current year, as new insurance habits grew and market returns improved. The US business represented 35% and the UK about 17%. The Pru is thus a big and growing overseas service provider for the UK, generating longer term profits. For the company as a whole, the EEV value of life business grew over 17% to £2.2 billion. The EEV value was reported as worth 1,170p a share. In consequence, the interim dividend was raised 10% to 12.3p a share.
The bad news in question was a Bloomberg report that China’s authorities are restricting the amount of insurance its citizens may acquire overseas; particularly that ‘big ticket’ item, single premium purchases of insurance cover costing $5,000 or more. Behind that is the concern of the Chinese authorities at the flight of capital from the country. Some of it lands up in UK property market and some evidently ends up as savings by single premium in the Prudential’s coffers. In a swift bit of analysis, one broker pointed out that on the laws of arithmetic, the China move was unlikely to be too much of a problem for the Pru because the Pru’s average sales figure since 2010 was below $5,000.
My first response was to cast an eye over the company’s last solvency ratio. I see from a note that the company’s estimated Group Solvency II surplus as at the last published balance sheet was a reported £9.2 billion, or in percentage terms 190% (before allowing for last year’s interim dividend). It is regarded as a good measure of the business’s cash generation and in the words of the company:
“We remain confident that the Group will be able to continue to deliver high-quality products and services to both new and existing customers and strong, sustainable, profitable growth for our shareholders.”
So, as a first step, we at least know that company is financially in good shape to deal with any slings and arrows of outrageous fortune that might come the Prudential’s way.
The Prudential may not be a high yielding share but it does have a dividend that has grown at an above average rate over the last few years. Although earnings per share have been up and down a bit since 2010, dividends have been increased each and every year since then; to the extent of growing at a reported rate of over 13% per annum. Moreover, the company has been doing that by leaving the major part of the earnings in the business as retained earnings. Last year, to December 31st 2014, the 36.93p dividend payout was covered 2.6 times by earnings of 96.6p. In consequence, balance sheet retained earnings last year increased 14% to the benefit of net assets which increased at about the same rate to £12.1 billion.
The shares reached a high of 1,761p almost a year ago on March 21st 2015. So at the current share price of 1,272p last seen, these shares have come down by about 28% from last year’s high and the rating of the shares was high in relation to current market consensus estimates for this year (these seem to have changed very little). Last March the shares were selling on a prospective estimated price to earnings ratio of 16 times forward current consensus estimated earnings of 109.7p and on a prospective estimated dividend yield of 2.3%. It is worth adding that over the last consecutive twelve months the share price has underperformed the FTSE 100 Index by about 7%. Astonishingly, this share has shown no defensive qualities despite the long-term nature of its business and its significant recent historic success. Clearly, the shares a year ago were overvalued.
Now, as a result of the share price fall, Prudential shares at 1,277p last seen are selling on 11.6 times last year’s estimated earnings per share and on an estimated, well covered, dividend yield of 3.1%. According to the same consensus estimates for the current year, Prudential equity is valued on 10.6 times estimated 2016 earnings per share of 120p and on a prospective estimated dividend yield of 3.4%. These combined with the last seen European embedded value and Group Solvency II values indicate that the shares look good value.
If the share price trend remains in a resolutely downwards direction, it quite reasonably offers room for a rally within that trend and no doubt an ultimate breakout once the market gets a clearer idea of its prospects, when last year’s figures are published in week or two. These shares offer a decent current estimated near-term dividend yield at a reasonable multiple of forecast earnings along with good financial fundamentals. They appear to be an attractive investment.
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