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Prudential - strong profit growth, US spin-off underway

Nicholas Hyett, Equity Analyst | 11 March 2020 | A A A
Prudential - strong profit growth, US spin-off underway

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Prudential plc Ordinary 5p

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Prudential reported a 20% increase in underlying operating profits, which reached $5.3bn, with strong growth in both the US and Asia across life insurance and asset management.

Alongside full year results the group announced that it's looking to float a minority stake in its US division, Jackson, on the stock exchange. That reflects the need to invest in diversifying the business and desire to draw in outside capital.

The board announced a second dividend of 25.97 cents per share.

The shares rose 2.6% following the announcement.

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Our view

Prudential is a rare case where the phrase "transformational year" might not be management hyperbole. Tellingly, CEO Mike Wells has steered well clear of it - genuinely transformational years can make people nervous.

Having spun off the M&G asset management and UK life insurance business at the end of last year Prudential was all set to begin life as an Asian and US focused business. Step in an activist hedge fund calling for a break-up, and now the US and Asian operations are going their separate ways too.

While Prudential will retain a majority stake in Jackson post the IPO we can see the rationale for a more distant relationship.

Firstly there's little intrinsic benefit to tying the two businesses together, and a high growth Asian business and more mature US division in one package confuses the investment case. Secondly, the US business is arguably overexposed to the volatile variable annuity business (on which more later) and diversifying is expensive. Attracting third party capital through an IPO will help spread the risk.

So where does all this leave Prudential investors?

It should mean the group is more focused on what we see as its most attractive opportunity - expansion in Asia. A focus on regular premium products like life and health insurance should make profits reasonably dependable. Coronavirus has the potential to see a spike in claims, but the fact premiums continue to roll in even when times are tough is reassuring. Looming trouble is hardly the time to cut back on insurance after all. Long term, a growing and increasingly wealthy population means demographic trends are in the group's favour.

Under the current plan investors will also retain a sizeable stake in Jackson, and we see efforts to diversify the product offering here as a major positive (especially given the substantial variable annuity book). The combination of rising stock markets and falling interest rates is a pretty toxic one for Prudential - extra cash is required to back the guarantee while the variable component is also paying out.

That said we think the US is attractive long term. Pru estimates that 4m Americans reach retirement age each year, creating significant opportunities for retirement income providers. Keeping exposure to that trend is no bad thing.

Overall we think Prudential is doing the right things, and is almost certainly the UK life insurer with the most growth potential. That explains the relatively modest yield, by life insurer standards, of 3.2%. Repeated major surgery isn't risk free though, and with the Jackson IPO details still thin on the ground it's something to keep an eye on.

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Full Year Results (constant exchange rates)

Asia accounted for the majority of operating profit in 2019, up 14% to $3.3bn. That reflects strong growth in both asset management (profits up 18% to $283m) and insurance (profits up 14% to $3.0bn).

Profits rose by double digit percentages in eight insurance markets, including 24% growth in Hong Kong and 20% growth in Mainland China. Meanwhile asset manager Eastspring saw average assets under management (AUM) rise 15% with $8.9bn of net inflows. Eastspring acquired a controlling stake in Thai asset manager Thanachart during the year.

Prudential's Asian business continues to strengthen its distribution relationships with banks across the region as well as investing in new digital services.

In the US profits rose 20% to $3.1bn. Insurance profits rose 19% $3bn, while the fledgling asset management division saw profits reach $32m. However, reported profits were actually negative, as a strong equity market and lower interest rates hit performance.

The group continues to invest in its small African business, which now operates in eight markets.

Total cash remittances from operating companies to the group rose 3% year-on-year to $1.5bn.

The group's LCSM cover ratio reached 309%, with a capital surplus of $9.5bn. This is a key measure of insurers' capitalisation applied by the Hong Kong regulator.

Despite potential disruption from coronavirus the group remains confident in its long term prospects. Customers continue to pay premiums and the board believes the attractiveness of its end markets remains unaffected.

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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 for more information.

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