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Prudential - core looks good as Jackson prepares to depart

Nicholas Hyett (Equity Analyst) | 11 August 2021 | A A A
Prudential - core looks good as Jackson prepares to depart

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Prudential plc Ordinary 5p

Sell: 1,287.00 | Buy: 1,288.00 | Change 6.50 (0.51%)
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Prudential reported a loss after tax for the half of $4.6bn, impacted by a $7.5bn writedown in the value of US life insurance business Jackson ahead of its planned demerger. Excluding Jackson the group reported a profit after tax of $1.1bn, up by 64% year-on-year at constant exchange rates.

The improvement in underlying profits reflects insurance sales growth across all regions other than Indonesia and Hong Kong, as well as improvements in asset management operating profit.

The board announced an interim dividend of 5.37 cents per share, in-line with last year's payout.

The Jackson demerger is expected to complete in September.

Prudential shares rose 1.2% in early trading.

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Our view

The decision to list Jackson as an independent company means Prudential's US and Asian businesses will have gone their separate ways by the end of this year. The move is creating some noise around first half results, with a big writedown in the paper value of Jackson. But this doesn't affect the fundamentals, and operating results are actually pretty good in our opinion.

We can see the rational for the separation. 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. The US business is also arguably overexposed to the volatile variable annuity business and diversifying is expensive.

Simplifying the business also creates cost saving opportunities. As well as lower head office costs the group is targeting savings through increased digitisation. Digital customers are cheaper to recruit and cheaper to serve, boosting margins or making product pricing more competitive - both ultimately good news for the bottom line.

We suspect the decision to demerge Jackson in one go, rather than the previously planned minority IPO, reflects the tough market conditions the US arm faces. The combination of resilient stock markets and falling interest rates is a pretty toxic one for variable annuities - extra cash is required to back the guarantee element while the variable component is also paying out. Demerging the business avoids the need to find a willing buyer by simply handing the business over to Prudential's existing shareholders.

Investors will ultimately be left holding shares in two very different businesses, and it's unlikely that both will be a good fit for the same portfolio.

The Asian business should benefit from long term economic development in its markets, driving increased demand for Pru's insurance products - since in many cases state sponsored social security has never got off the ground. A focus on regular premium products like life and health insurance should also 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.

Unfortunately selling more insurance products means holding more capital. And a demerger of Jackson rather than a sale means there won't be any extra cash coming into the business - which probably explains why an additional fundraising is under consideration. A decent sized asset management business offsets that to some degree, but the focus on Asia still comes at the cost of a smaller dividend, with a prospective yield of just 0.9%.

By comparison Jackson is more mature - and while there's still scope for growth, the dividend will be a far more important part of the story. However, the group's exposure to variable annuities remains something of a headache and will require attention in the years to come. The group has an impressive distribution network, but building expertise outside variable annuities will demand time and capital.

Overall, we think Prudential's doing the right thing. It's good to see management putting the business's, and investors' long term interest front and centre. However, this break-up has been messy and with extra fundraising on the horizon the final picture is still unclear.

Prudential key facts

  • Price/Book ratio: 2.82
  • 10 year average Price/Earnings ratio: 2.69
  • Prospective dividend yield (next 12 months): 0.9%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Half Year Results

Life Insurance new business sales across Asia and Africa rose 17% at constant exchange rates to $2.1bn. That reflects very strong growth in Mainland China, Malaysia and Singapore, although sales declined 35% in Hong Kong and Indonesia also struggled. That reflects strong growth in agency and bank channels, while the group's direct to consumer Pulse app accounted for 10% of sales in markets where it is available. Operating profits from the group's life and other long term business came in at $2.0bn.

Funds under management in the group's asset management businesses, Eastspring, rose 16% to $254bn. That was driven by funds from the group's insurance products and market movements. The division saw net outflows from external clients of $509m, an improvement on the $8.4bn recorded in the same period last year. The division reported underlying operating profits after tax of $147m, up 17% year-on-year.

The group's operating free surplus, a key measure of cash generation, rose 9% to $965m. That was driven by increased surpluses from in-force insurance business and increased asset management profits, offset by the capital required to underwrite in new insurance contracts.

The group's GWS capital position, capital requirements set by the Hong Kong regulator, remains strong with a $10.1bn surplus and 383% coverage ratio. That compares to a $9.4bn surplus and 370% coverage at the start of the year.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.