Just Group, unjust rating

Fundamental analysis can either begin with an estimate about a company’s future cash flows and profits, or the market value of the assets and liabilities on its balance sheet. Neither is a totally distinct nor clear-cut process, particularly when it comes to intangibles such as brand value or second-guessing long-term changes in customer behaviour, cost inputs and market competition

Indeed, it can be complicated even when sales are growing, capital levels are improving, and risk is being removed. Retirement benefits specialist Just Group (JUST) is a case in point.

When Just presents its full-year results on 11 March, the FTSE 250 constituent’s tangible net asset value looks set to at least match the 204p a share recorded at the end of June, itself a 23p increase on the end of 2019. And yet the share price is almost two-thirds less than that figure, with the market believing instead that equity value is headed for material punishment. In the FTSE 350 Index, only rent-sapped shopping centre landlord Hammerson (HMSO) trades at a sharper discount to book value, according to FactSet data.

Just concern

Why, then, should investors have doubts? The first place to look, as we did when we flagged the shares’ miserly rating during last spring’s market collapse (52.8p, 19 Mar 2020), is to 2018. That was the year when Just shareholders were hit by revisions to mortality and property price assumptions, and later caught short by tighter capital requirements for equity-release mortgages. The dividend and chief executive both went, and equity holders were tapped for £75m in new shares at 80p as part of an emergency capital raise.

With the shares only now edging back to that bail-in price, market forgiveness has been hard won. But while immediate concerns around capital have abated, two new worries have emerged. One is the scope for quality top-line growth, which analysts at Keefe, Bruyette & Woods (KBW) view as constrained by uncertain demand for individual underwritten annuities, and Just’s ability to deploy capital at a sufficiently fast pace into the high-growth bulk annuity de-risking market.

Both product lines require some explanation and context. According to Just, demand for individual annuities (broadly grouped into the company’s ‘guaranteed income for life’ products) has been growing at more than 5 per cent a year, and is a market now worth more than £1 trillion in the UK. Just saw a recovery in the sale of these policies in the second half of 2020, after pandemic-linked disruption led to a 10 per cent drop in the first half (see sales focus chart).

To KBW, lower interest rates and the risk of weak equity markets could affect demand. Somewhat paradoxically, the brokerage also thinks less attractive standard annuity rates could “drive further demand for underwritten products”. That certainty many retirees look for isn’t going away. Neither are pension freedom reforms and widespread workplace defined contribution pension schemes, both of which act as drivers of new business.

Just has also shown it can write new premiums without suffering from so-called business strain, which is the upfront cost to capital of writing and funding a new insurance policy. After falling at the half-year stage, capital strain declined further in the six months to December, even as Just sold a record £1.05bn in bulk annuity products to employers and pension schemes wanting to fully or partially de-risk the onerous task of meeting defined benefit members’ liabilities. Demand here is massive, and set to continue: Just expects total addressable sales of £40bn a year over the next decade, suggesting capital, net assets and cash flow can grow.

Corporate actions have also helped, such as the issue of £250m in green bonds in October, which lifted the group’s pro-forma solvency capital ratio – the buffers insurers are required to hold should all their obligations come due at once – to 154 per cent. Brokerage RBC also expects downward revisions to longevity assumptions, tragically hit by the past year’s excess deaths, will add a further four percentage points.

The property question

The other concern is the possibility of a major correction in the property market, to which Just is heavily exposed through its portfolio of equity release mortgages, which allow homeowners to borrow money secured against the equity in their home (see asset portfolio chart). Specifically, the key fear surrounds the “no negative equity guarantees” (NNEGs) which accompany these mortgages, and the prospect that Just could be forced to cover the difference should a house sell for less than the value of the mortgage.

Absent the collapse of the property market, worries here seem overdone. For a start, Just has incurred only £1.9m of NNEG claims out of £2bn-worth of redemptions since it started writing lifetime mortgages in 2005, implying a cost of risk of just 10 basis points. Bears would point to a largely benign backdrop for house prices in this period, which also helps explain why regulators require providers to hold plenty of capital in case things go wrong. House price inflation is also trending well above Just’s assumptions, which helps.

To lower its exposure, management recently sold a £540m book of mortgages (at book value) and entered into its third NNEG hedge, meaning a fifth of the mortgage portfolio – along with Just’s balance sheet – has been de-risked. If anything, exposure to speculative grade bonds in the asset portfolio looks more of a potential issue, despite assurances of the portfolio’s prudent positioning and diversification.

Finding value

Given signs of momentum, it’s a wonder why Just sits on such a punished valuation, even by the standards of the life insurance sector.

Earlier this month, RBC hosted a call with Just chief financial officer Andy Parsons, in which he was asked why the company had not yet been bought. “We are open to conversations from interested parties and conversations have happened,” Mr Parsons reportedly said. “All we can do is to focus on ourselves – making our business better will increase the appeal to others.”

RBC took this to mean that interested parties will need to bid closer to 200p for a sale to be considered, although a Just spokesperson declined to expand beyond chief executive David Richardson’s comments that 2021 had started “with increased confidence”.

We expect long-term shareholders, many of whom remain underwater, will feel the same. Recent precedent is on their side: last September, the private equity giant Blackstone sold a 36 per cent stake in bulk annuity competitor Rothesay Life at a £5.75bn valuation, or equal to Rothesay’s net asset value. Recent activity in the insurance M&A market implies long-term investors are prepared to take a long-term view of cash flows, particularly with yields compressed elsewhere.

Against this backdrop, the average City target price of around 100p a share (see chart) is a solid starting point. If Just’s turnaround strategy remains on course throughout 2021, a bid does not seem fanciful.

Last IC View: Buy, 57.7p, 13 Aug 2020