Are shares in Legal & General (LGEN) suspiciously cheap? That’s one potential conclusion from the latest iteration of our Alpha growth at a reasonable price (GARP) stock screen, which graded the insurer-cum-asset manager as the only FTSE 100 financial services company to meet at least six of its eight criteria. Had its price/earnings ratio been higher – placing it among blue-chips closer to the middle of the valuation range – then another box would have been ticked. But while the complex moving parts of L&G’s various divisions mean the metric has its limits, the single-figure PE ratio does look strikingly (potentially alarmingly) good value based on consensus forecasts are for underlying EPS growing 10 per cent this year, 6 per cent in 2020, and 8 per cent a year until 2022.
Surplus capital
Attractive dividend
Non-sterling assets
Pension risk transfer growth
Uncertain outlook
Solvency II drop
So how do we explain the market’s apparent indifference to these metrics? The first reason is the potential headwinds from falling interest rates as well as uncertainty created by Brexit and the potential impact of the US/China trade war on global markets. A more quantifiable cause for investor reticence is the company's Solvency II coverage ratio – the capital European insurers need to hold to withstand shocks – which fell from 193 to 171 per cent in the 12 months to June 2019. However, the trend should reverse by the end of 2019, as disposals, potential releases and operational surplus generation. With 42 per cent of L&G’s funds already classed as surplus capital, we see little threat to the progressive dividend policy that has underpinned a 14 per cent compound annual dividend growth rate between 2011 and 2018.
Another potential concern is the lumpiness of large business wins, as reflected by the bumpy profit-progress in the accompanying table. While pre-tax profits rose 12 per cent in the first half of 2019, the over-sized contribution from individual annuity sales and a £4.6bn bulk annuity deal with Rolls-Royce has led some analysts to question the sustainability and consistency of L&G’s largest single source of profits. But so long as the back-book is growing, operating profits should have a good foundation.
Some investors might be cautious around L&G’s credit exposure, although we think the reserves and credit rating of the retirement business bond portfolio look strong. As for Brexit uncertainty, it’s worth noting that most external net flows to L&G’s investment arm are now international, while assets under management (£1.1 trillion at the half year) are growing and largely denominated in non-sterling currencies. Premiums from new international pension risk transfer mandates are on course to pass £1bn this year, from just £347m in 2016. And investments made by L&G’s capital arm are focused on long-term businesses such as renewable infrastructure, affordable homes and third-party property developments.
| Legal & General (LGEN) | |||||
| ORD PRICE: | 236p | MARKET VALUE: | £14bn | ||
| TOUCH: | 236-236.8p | 12-MONTH HIGH: | 292p | LOW: | 215p |
| FORWARD DIVIDEND YIELD: | 8% | FORWARD PE RATIO: | 8 | ||
| NET ASSET VALUE: | 149p | SOLVENCY RATIO: | 171% | ||
| Year to 31 Dec | Gross premiums (£bn) | Pre-tax profit (£m)* | Earnings per share (p)* | Dividend per share (p) | |
| 2016 | 6.63 | 1.58 | 21.1 | 14.4 | |
| 2017 | 6.96 | 2.09 | 31.7 | 15.4 | |
| 2018 | 7.31 | 2.13 | 30.6 | 16.4 | |
| 2019* | 7.67 | 2.77 | 38.1 | 17.6 | |
| 2020* | 8.06 | 2.22 | 30.6 | 18.8 | |
| % change | +5 | -21 | -20 | +7 | |
| Normal market size: | 7,500 | ||||
| Beta: | 1.83 | ||||
| *JPMorgan forecasts, adjusted PTP and EPS figures | |||||
