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Legal & General - bumper profit growth, dividend up

Nicholas Hyett, Equity Analyst | 4 March 2020 | A A A
Legal & General - bumper profit growth, dividend up

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Legal & General Group plc Ord 2.5p Shares

Sell: 282.20 | Buy: 282.40 | Change -15.20 (-5.10%)
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Full year operating profit rose 12% year-on-year to £2.1bn. While growth was spread across all divisions the institutional retirement business delivered a particularly strong set of results.

The board recommended a final dividend of 12.64p per share, taking the full year payment to 17.57p, up 7%.

The shares were broadly flat in early trading.

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Our view

We think Legal & General has built an impressively coherent business where each division complements each of the others nicely. That's helped the group's brand of 'Inclusive Capitalism' to pay dividends.

Legal & General Retirement writes annuities for individuals and pension funds. While the group's retail annuity sales are growing quickly the real money spinner is bulk annuity deals - where the group takes on liabilities from final salary pension funds.

In return for writing annuities the group receives huge lump sums. These are managed by LGIM and underpinned with real assets developed by the Capital division (which includes UK housing and infrastructure projects). LGIM's low cost tracker and liability driven investment strategies are popular with other final salary pension schemes who can become future bulk annuity customers (over the last 3 years 51% of bulk annuity customers were previously LGIM customers).

We view the business model as a major competitive advantage for the group, since replicating all the various areas of expertise is difficult and time consuming. However, we also think the end markets to which the group is exposed offer long term growth potential.

Demand for bulk annuities is growing, and as well as a dominant UK position, L&G is increasing its exposure in overseas markets like the US and Canada.

International customers are accounting for an increasing large slice of the assets under management in LGIM too. Together with a leading position in low cost passive investment products that's helped the group become the UK's first £1trn investment manager. We think growth will continue going forwards - with a formidable defined contribution pension business a potential source of growth for years to come.

Not all growth is good growth though and we actually find a slowdown in Lifetime Mortgage sales reassuring. 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 - but given potential for regulatory headaches in an emerging market a disciplined approach to new business is welcome.

Investors should be aware that L&G's sizable investment portfolio does make it sensitive to movements in the wider market, and coronavirus disruption has hurt. We suspect that explains the fall in the group's Solvency ratio in the early months of this year and an economic downturn will slow further progress.

Longer term, we think L&G is well set, supported by wider economic and demographic trends. We feel the group's capital position is solid, and the shares offer an attractive prospective yield of 7.2%. Analysts expect steady dividend increases from here - although as ever dividends are variable and not guaranteed.

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Full Year Results

Legal & General Retirement (LGR) reported operating profits of £1.4bn, up 26.8% year-on-year. That reflects good growth in both the institutional and retail businesses.

LGR Institutional wrote £11.4bn of bulk annuities during the year, across 42 separate deals. The group retained its market leading position in the UK market, which hit another record high this year, with significant growth both in the US and overseas as well.

LGR Retail annuity sales rose 22% to £970m. The group has now more than doubled its UK annuity market share since 2016. Lifetime mortgage sales fell 19% year-on-year to £965m as competition increased, although the group maintained a 25% market share.

Operating profits in Legal & General Investment Management (LGIM) rose 3.9% to £423m. That reflects a 17.8% increase in Assets Under Management (AUM), now at £1.2trn, driven by £86.4bn of net inflows. International flows continue to account for the majority of new assets, with the group adding a contract to manage £37bn of the Japanese government pension fund. New assets from Defined Contribution pension schemes also grew strongly.

Legal & General Capital (LGC), which looks after the groups own investments, saw profits rise 12.7% to £363m. That reflects increased investment in direct real assets - particularly housing - with the group's traded investment portfolio also performing well.

Legal & General Insurance (LGI) saw profits rise 1.9% to £314m mainly thanks to improved US results. Lower yields on government bonds were a headwind, although gross written premiums increased 5.8% year-on-year.

Mortality releases in LGR fell from £433m last year to £155m this year - based on 2017 mortality tables.

Legal & General finished the year with a Solvency II ratio, a key measure of insurer capitalisation, of 184% (2018: 188%). That follows surplus capital generation from operations during the year of 9%. However, more recent estimates have seen the ratio fall to 174%.

Releases from continuing operations (gross cash profits) rose 15% to £1.6bn.

Return on equity fell from 22.7% last year to 20.4% this year.

Return on equity in the half was 20.2%.

Find out more about Legal & General shares including how to invest

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 for more information.