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M&G - profits down but in line with expectations

Sophie Lund-Yates, Equity Analyst | 10 March 2020 | A A A
M&G - profits down but in line with expectations

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M&G plc ORD GBP0.05

Sell: 193.30 | Buy: 193.50 | Change -2.90 (-1.48%)
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Underlying operating profit of £1.1bn was 29.1% lower than last year, but this was in line with management's expectations. The decrease largely reflects a lower annuity margin.

The group announced an ordinary dividend of 11.92p, and a special demerger payment of 3.85p per share.

The shares rose 4.2% following the announcement.

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Our view

Following the demerger from Prudential, M&G is made up of M&G asset management and Prudential's UK life insurance business.

On the plus side, M&G is looking to pass on a lot of its legacy UK life liabilities. That should leave it managing the assets without taking on the risks inherent in life insurance. That's a potentially attractive place to be, because compared to life insurance, asset management is a capital light business.

The amount of capital asset managers are required to keep on hand is much lower than it is for life insurers. That's because life insurers have obligations to their customers and meet those by investing the premiums they receive. But as there's always the risk the investment doesn't generate the level of return expected, regulators insist life insurers hold a certain amount of capital to meet obligations. Shareholder money is essentially tied up doing not a great deal.

For asset management, it's the client taking the investment risk, so regulatory rules are less stringent. That frees up cash, which can be returned to shareholders or invested to fund new growth.

Combining conventional fund management with legacy life insurance and a growing with-profits funds business has given the group scale with £352bn of assets under management (AUM) and administration. And in fund management scale is key. Once the costs of running a fund are covered all the extra management fees are profit.

It's not all plain sailing though. The rise of low cost passive investing has made investors increasingly price sensitive, and active management fees are under pressure as a result. The PruFunds line of with-profits funds is selling well, but the product gets treated with suspicion by many UK investors and the UK is a relatively mature market in any case. Growth in AUM could be hard to come by, and revenue growth even more so.

Wider uncertainty in global markets thanks to coronavirus is an extra headwind too, with the group's Solvency II Ratio (a key measure of its capitalisation), dropping as a result. The indicators are far from flashing red, but it's one to watch.

All-in-all the short-term outlook will likely remain challenging. Looking further ahead conditions should stabilise, but we find it hard to see how growth can really accelerate from here. The shares currently offer a 10.4% prospective yield, which suggests we aren't alone in thinking growth could be a struggle. Remember, yields are variable and not guaranteed.

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Full Year Results

Heritage which includes annuities and 'with-profits' funds , saw underlying operating profit fall 35.4% to £752m. That was the result of a much lower annuities margin, driven by lower mortality assumptions, and an FCA fine associated with the review of annuity sales practices. Fee based revenue was flat at £96m.

Assets under management in the traditional Heritage with-profits business was broadly flat at £84.8bn, while the annuity book grew to £35.5 billion (2018: £24.9bn), reflecting reinsurance assets from Rothesay Life plc.

In the Savings and Asset Management business, adjusted operating profit rose 1.3% to £474m, driven by increased investment income. Asset management activities saw lower profits, due to a decrease in average assets under management and a 7.2% drop in fees to £1bn.

Fee margins were 0.02 percentage points lower at 38%, reflecting "industry wide pressure on fees in Retail Asset Management because of the popularity of passives and changes in the distribution landscape". Costs also increased due to higher investment management staff and premises costs, and as a result the cost:income ratio was 63% compared to 59% last year.

PruFund saw net client inflows of £6.4bn, which helped PruFund assets under management increase 25% to £53.8bn.

M&G temporarily suspended dealing in the M&G Property Portfolio Fund following a period of sustained redemptions in December 2019.

The business finished the year with a Solvency II ratio of 176%, up from 170% last year. M&G said this is a comfortable level, within its risk appetite. More recently the Solvency II ratio was around 166%, reflecting volatility in global markets from coronavirus.

In response to the challenging active management landscape, M&G hopes to lower staff costs by 10% in 2020 and has launched a voluntary redundancy scheme. The group remains on track to achieve average annual run-rate cost savings of £145m by the end of 2022.

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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.