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Legal & General - All eyes on the second half

Nicholas Hyett | 9 August 2018 | A A A
Legal & General - All eyes on the second half

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Legal & General Group plc Ord 2.5p Shares

Sell: 256.40 | Buy: 256.70 | Change -4.20 (-1.61%)
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Underlying group operating profits rose 5% to £909m in the first half, as increased investment in digital capabilities partially offset operating profit growth across all but one of Legal & General's divisions.

The group announced an interim dividend of 4.6p, a 7% increase on last year.

The shares were broadly flat in early trading.

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Our view

Legal & General serves markets with a lot of growth potential.

It's a market leader in low cost investment products, with 326bn in index funds. Meanwhile auto-enrolment has seen L&G become the UK's largest defined contribution pension manager, with Workplace customer numbers up 21% to 2.9m.

Changes to pension rules in 2014 demolished L&G's annuity sales, but they're growing again, up 78% in 2017. Meanwhile demand for the group's bulk annuity schemes and liability-driven investment products should remain strong, as companies seek to de-risk existing defined benefit (DB) pension schemes. The UK DB market alone is worth an estimated 2trn.

Although the UK is still the group's centre of gravity (and with current economic headwinds that could yet prove a problem), international expansion should open up further opportunities. International flows accounted for 82.5% of investment management net inflows in 2017, while the US DB market is significantly larger than the UK, and demand for de-risking solutions is growing rapidly.

Recent times have seen the group benefit from "mortality releases" from its annuity portfolio, as life expectancy fails to increase at the pace actuaries had been expecting. Those one off-gains won't continue forever, but expected to provide a significant boost to second half results.

Among the areas the group is looking to grow longer term is Lifetime Mortgages.

These equity release deals allow customers to take money out of their house while continuing to live there, with the loan only repaid on the borrower's death or house's sale. Growth has been spectacular - rising from nothing to 1bn of advances per annum in just three years. A low average loan-to-value provides some assurance the group hasn't been over reaching itself, but it's still an emerging sector, and new sectors can come with unexpected risks. We'll be keeping a close eye on it.

Longer term, L&G appears well set, operating in markets which benefit from wider economic and demographic trends. The capital position is solid, and the shares offer an attractive prospective yield of 6.6%, with analysts expecting steady dividend increases from here.

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Half Year Results

Legal & General Retirement remains the largest contributor to group performance, with operating profits of £480m. At a reported level this is 15.2% below last year, due to the non-recurrence of a £126m mortality release in 2017 numbers from changes to life expectancy. Excluding this mortality release, divisional profits rose 9.1%.

The divisions has delivered a very strong performance in lifetime mortgages, with advances up 22.9% to £521m. Bulk annuity deals are expected to increase substantially in the second half, with L&G currently quoting on over £20bn of pension risk transfer deals. Based on recent trends the group expects mortality releases of between £300m and £400m in 2018.

The asset management business, Legal & General Investment Management, saw assets under management (AUM) increase 3.6% to £984.8bn. That includes external net inflows of £14.6bn, with particularly strong results from the defined contribution business. Higher AUM meant divisional operating profit rose 4.6% to £203m.

Legal & General Capital, which manages L&G's proprietary investments, saw a 21.1% jump in operating profits, hitting £172m. Within that, the direct investment portfolio (which includes housing, clean energy and SME finance) grew by £657m year-on-year to £2bn and generated profits of £104m, while the trading portfolio delivered a profit of £64m.

Legal & General Insurance posted an operating profit of £154m, up 4.8% on last year, while General Insurance fell to a £6m loss following poor weather conditions earlier in the year.

L&G's solvency ratio (a key measure of insurer capitalisation) rose to 193% (2017: 186%) adding £0.7bn to the group's surplus which now stands at £6.9bn.

Management continue to expect earnings per share to grow by 10% a year out to 2020.

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The author holds shares in Legal & General.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.