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Legal & General - confident in outlook, debt raise

Nicholas Hyett, Equity Analyst | 24 April 2020 | A A A
Legal & General - confident in outlook, debt raise

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Legal & General Group plc Ord 2.5p Shares

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Legal & General remains 'confident' in its outlook for the first half of the year despite the disruption caused by coronavirus.

Legal & General Capital (LGC) is the most directly impacted business, with construction operation paused, although some units have subsequently reopened. As a result the group now expects LGC's operating profits to be down year-on-year.

The group's bond portfolio has experienced less downgrades to sub-investment grade than the wider market and has limited exposure to airlines, hotels, leisure and traditional retail.

The group is looking to raise additional debt to "capitalise on new business opportunities" as they arise, with the exact amount to be confirmed after completion.

Legal & General shares fell 2.8% on the day of the announcement.

View the latest Legal & General share price and how to deal

Our view

Legal & General's built an impressively coherent business, with each division complementing each other nicely. And, so far at least, those businesses seem to weathering the coronavirus outbreak rather well.

Demand for the group's annuities remains strong from both institutions and individuals. That's good to hear, since institutional bulk annuities have been the real money spinner in recent years.

In return for writing annuities the group receives huge lump sums. These are managed by Legal & General Investment Management (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 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 found a recent 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 though that L&G's sizable investment portfolio does make it sensitive to movements in the wider market, and coronavirus disruption has hurt.

The bond portfolio that underpins the group's £75.9bn annuity book has so far weathered the storm well. Still it's something to watch going forwards, and it manifests itself in the group's Solvency Ratio. Given LGIM charges a percentage of assets under management market falls will hit revenues here too.

Fortunately the group's capital position is pretty good in our view, strengthened further by the new debt raise. Management's decision to pay the 2019 final dividend, when several other insurers cut theirs, suggests that's a view shared internally.

Analysts are currently forecasting a prospective dividend yield of 9.7% for the next 12 months. High yields are often a warning sign that investors are worried the company can't deliver and investors should be careful not to dismiss those fears out of hand. While we think L&G is well set long term, supported by wider economic and demographic trends, the impact of the coronavirus outbreak is unknown and a major economic downturn and slow recovery could transform conditions for the group.

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Full Year Results - 04/03/20

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%.

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.

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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.

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