Legal & General (LGEN) is preparing to say goodbye to its long-serving and much respected chief executive, Sir Nigel Wilson, in December, but from a share price perspective, the second half of his decade-plus tenure has proved far less auspicious than his first. The shares have underperformed over the past year in particular, first as the company narrowly avoided being caught up in the liability-driven investing (LDI) scandal unwittingly unleashed by the government’s disastrous mini-Budget last autumn, then as higher rates hit certain parts of its business.
However, what matters most for income investors is whether the company’s dividend – which, given the current forward yield of 8.8 per cent is one of the few inflation-beating payouts available on the FTSE – will keep flowing and growing during a period of reorganisation and transition to new management, a looser regulatory regime and a wider invested asset base as its investment management arm expands into alternative asset classes. With so much potential change afoot, what can investors expect?
Many of the factors that affect the share price are beyond the control of management. For example, it is heavily correlated with the state of corporate credit markets – L&G is a major holder and buyer of corporate debt – along with the UK housing and commercial property market, where price weakness has an impact on its invested assets. Interest rate rises are key to understanding the nature of this correlation. While higher interest rates can be a positive for the company, in part because they drive up the return on its cash assets, they also affect both the value of its bond portfolio – with yields rising, giving way to potential mark-to-market losses on long-dated debt, the share price has been marked down in response.
Luckily, rate rises are also changing dynamics in the defined-benefit pension fund market, to the extent that many more maturing schemes are now considering transferring liabilities to life insurers. Higher rates have helped to push pension funds into surplus, which makes the transfer process more feasible. The pension risk transfer segment (PRT) of L&G's institutional business is generating record profits as a result; operating profit for this division in the first half of FY2023 alone was enough to cover 40 per cent of the entire value of the £1.1bn dividend paid out in 2022. The company is also increasingly diversified, with £2.2bn of PRT business written in North America, more than double previous years. When the additional contribution from L&G's asset management arm is taken into account, it's clear the business has a spread of revenue that is able to support the underlying shareholder payout.
The company aims to continue raising the dividend by 5 per cent through 2024, although a change in accounting methods due to IFRS17 means it must take greater account of the solvency position in relation to the size of the payout, which will be subject to an annual decision by the board. L&G says this will not affect its dividend plans, and analyst consensus has the payout rising by 5 per cent for many years to come. Berenberg analysts are on the more bearish side in believing that growth will be minimal in the near term.
Then there are buybacks. L&G has consistently eschewed buybacks in favour of investing in the business, which disappointed the market at the latest interims last month. Like all insurers, the company’s solvency position must be hedged, and tying up excess capital in transfer deals is one way of locking in naturally higher levels of solvency, which might otherwise be diluted by buybacks. Yet analysts at Jefferies still think there is a chance of a buyback being announced alongside full-year results. Overall, the solidity of the yield is not in question, particularly with a typical dividend cover of 1.8, but do not expect income growth fireworks.
