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Shares in closed-life fund specialist Phoenix tumbled on news of an FCA probe into that niche sector - but those worries look overdone
April 10, 2014

Shares in the life assurance sector's closed-life companies tumbled heavily late last month after news emerged that the Financial Conduct Authority (FCA) was planning to probe that market. Phoenix (PHNX) wasn't spared any of that slide in sentiment the closed-life specialist's shares tumbled 12 per cent on the back of the news. But clarification from the FCA suggests that its planned investigation is unlikely to represent quite the threat that investors had originally feared, leaving the share price derating looking overdone. Moreover, Phoenix's impressive cash generation supports an impressive dividend yield.

IC TIP: Buy at 654.5p
Tip style
Income
Risk rating
High
Timescale
Long Term
Bull points
  • Fat dividend yield
  • Throwing off cash
  • Ready for acquisitions
  • Shares cheaply rated for the sector
Bear points
  • FCA probe has hit sentiment
  • Some exposure to annuity reform

Specifically, Phoenix's shares slipped after news reports suggesting that the FCA planned a review of life and pensions policies sold between the 1970s and 2000, covering some 30 million customers - driving fears that another large-scale mis-selling type probe might be under way. But the FCA's clarification statement some hours later suggested a more benign agenda - focused on "fair treatment" of long-standing customers and which specifically excluded "a review of sales practices for these legacy customers". The probe - which won't even begin for another three months - will focus on service levels provided to clients with policies held in closed books. Analysts think cross subsidisation, in particular, is likely to face scrutiny - whereby closed books might be disproportionately charged to support new business generation.

But such a regulatory agenda is unlikely to represent much threat to Phoenix. To begin with, it writes very little new business - it only sells some annuities to existing maturing customers - so fears that it may be unfairly charging closed book customers to support news business isn't really relevant. Moreover, analysts at broker Canaccord Genuity are confident that Phoenix's existing administration charges "will not be deemed 'rip-off' charges" by the FCA. True, the small amount of new annuity business that Phoenix does currently write could be affected by the Budget day decision to axe compulsory annuity purchases. But here, too, the impact is likely to be modest - analysts at Deutcshe Bank believe this activity generates just 1 per cent of its profit.

PHOENIX (PHNX)

ORD PRICE:654.5pMARKET VALUE:£1.47bn
TOUCH:653.5-654.5p12-MONTH HIGH:810pLOW: 562p
FORWARD DIVIDEND YIELD:9.1%FORWARD PE RATIO:14
NET ASSET VALUE:849pEMBEDDED VALUE:1,058p

Year to 31 DecGross premiums (£bn)Operating profit (£m)Earnings per share (p)*Dividend per share (p)
20111.47387-76.242.0
20121.6142922747.7
20131.3343968.253.4
2014*na28247.056.1
2015*25848.059.5
% change--9+2+6

*JPMorgan Cazenove estimates, adjusted EPS

Normal market size: 3,000

Matched bargain trading

Beta: 0.90

Of more importance is Phoenix's impressive cash generation. That reflects the fact that Phoenix doesn't need to allocate much capital to support new business, so capital requirements for operating its closed book decline as policies mature. This in turn boosts cash flow and, in 2013, it generated £817m in cash - significantly beating its £650m-£750m target. It now expects cumulative cash flow from operations for 2014-19 to reach £2.8bn. That's great news for the dividend and the shares already boast a prospective yield of 8.6 per cent in 2014 rising to over 9 per cent in 2015 - the best yield in the UK life assurance sector.

Of course, without new acquisitions, the business will eventually run down to nothing - so some of that cash must be used to buy up additional closed books. Acquisition prospects, however, haven't looked so good lately - not only did talks in November regarding Swiss Re's closed-life business come to nothing, but the group's debt burden has also looked like a constraint. That situation, however, improved significantly last month after agreeing to sell its Ignis asset management arm to Standard Life (SL.) for £390m. Those proceeds will bring the gearing ratio to below 40 per cent - a level that management feels sufficiently comfortable with to push ahead with further deals. Moreover, with around £200bn of assets within closed-life funds in the UK - mainly in large UK life players, foreign insurers and UK banks - management believes targets won't be hard to find.