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Doubling down on L&G

The life assurer's dividend remains well supported even if the industry faces challenges
December 13, 2018

After a near-decade bull market, equities have experienced a sharp decline since the end of September. Some take the view that recent market volatility has created distinct buying opportunities, particularly for income-seekers, although anyone looking to take a new position in the market will need to ask themselves whether the markdowns represent a temporary correction or part of a sustained downtrend.

IC TIP: Buy at 231.4p
Tip style
Income
Risk rating
Medium
Timescale
Long Term
Bull points

Solid cash-flow conversion

High dividend payer

New British Airways deal

Distributions paid from surplus cash

Bear points

Irregular returns on pension risk transfer

Sensitive to a market sell off

That caveat aside, with the tide rolling back, we think it is worth re-examining the investment rationale for an existing IC buy recommendation. Shares in Legal & General (LGEN) have shed around 15 per cent of their value since our mid-year income call (Buy, 272.8p, 7 Jun 2018). This means that the FTSE 100 constituent now offers a prospective dividend yield of 7.1 per cent. Too good to be true or a true bargain thrown up by volatile markets?

Normally, a yield of that magnitude should serve as a red flag, but in this instance there's a chance the shares could make good on their promise. True, there are problems linked to the insurance group’s exposure to the individual annuities market, but there has been plenty of time to adapt since pension freedom reforms were introduced back in 2015. More pertinently, there is the market sell-off since October to consider and the sensitivity of the broad range of financial services offered by L&G.

Importantly, though, the group is doing what it can to forge ahead in the areas it has control over. Management is confident that new product innovation will eventually boost market volumes in individual annuities, although you get some idea of the scale of the industry shortfall when you set L&G’s individual annuity single premiums of £337m in the half year to June, against the £1.28bn it garnered throughout 2013.

However, L&G is making impressive gains in other areas. Pension freedoms gave rise to an industry-wide swing to the bulk annuities market. This area is benefiting from structural change, as businesses increasingly ditch their pension obligations by passing on their defined-benefit pension schemes to insurers. And L&G could be in for a big year. The group has reported a number of wins, while industry consultancy Willis Towers Watson expects deal values to rise to £30bn next year, a 20 per cent hike on the record rate forecast for 2018.

After a sharp fall in pension risk transfer (PRT) through the half year to June, L&G management guided towards bulk annuity volumes being weighted to the latter half of the year. And in September, the group duly completed the UK's largest bulk annuity deal, taking on £4.4bn of pension liabilities from British Airways. These transfers tend to be drawn-out affairs, and business wins do not represent the kind of predictable stream of work that investors tend to prefer. Nevertheless, the potential is huge given the rate at which this market is developing.

All these pension pots need to be invested somewhere. Group chief executive Nigel Wilson thinks that, unlike the banking sector, insurers can secure attractive returns on their investments by matching long-term assets to long-term liabilities. So L&G is stepping up its efforts to exploit infrastructure deficits in the UK and the US. The strategy certainly chimes with the Trump administration’s proposals on infrastructure, which entail a substantial funding element from the private sector. Mr Wilson thinks the infrastructure deficit in the US effectively runs into the trillions – that represents a genuine commercial opportunity for the investment arm.

LEGAL & GENERAL (LGEN)   
ORD PRICE:231.4pMARKET VALUE:£13.79bn
TOUCH:231.4-231.5p12-MONTH HIGH:288pLOW: 228p
FORWARD DIVIDEND YIELD:7.7%FORWARD PE RATIO:7
NET ASSET VALUE:129pSOLVENCY II RATIO:193%
Year to 31 DecGross written premiums (£bn)Pre-tax profit (£bn)*Earnings per share (p)*Dividend per share (p)
20156.321.3518.213.40
20166.631.5821.114.35
20176.961.9831.715.35
2018*7.312.0528.016.42
2019*7.682.6035.617.57
% change+5+27+27+7
Normal market size:7,500   
Matched bargain trading    
Beta:1.01   
*JPMorgan forecasts, adjusted PTP and EPS figures

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