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Legal & General's dividend underpinned

The need to take risk out of future pension payments is driving demand for the life insurer's products
June 7, 2018

Rising demand to take the uncertainty out of future pension payments is driving earnings growth for Legal and General (LGEN). During the five years to 2017, the life assurer grew earnings per share at a compound annual rate of 18 per cent. What’s more, the life assurer has a solid track record for turning those earnings into cash. Its net release from its operations – previously defined as net cash generation – was £1.45bn last year, up from £1.26bn in 2015. That has backed a growing dividend, which was increased to 15.35p in 2017 and has compounded at 15 per cent a year over the past five years. That should continue for a while – on average, City analysts forecast a 17.4p payout for the current year, which would generate a 6.4 per cent yield, rising to 18.4p for 2019 and a 6.7 per cent yield.

IC TIP: Buy at 272.8p
Tip style
Income
Risk rating
Medium
Timescale
Long Term
Bull points

High dividend yield

Dividend well covered by earnings

Cash generation improving

Rating lower than rivals 

Bear points

Individual annuity market still dull

Bulk annuity income lumpy

Legal and General’s (L&G's) retirement businesses led the way in boosting operating profits last year, which were up more than half on 2016. True, much of that uplift was due to a change in mortality assumptions, used for calculating the amount of money needed to be set aside to make pension payments. Shorter life expectancies meant £332m in reserves could be released. However, even without that bookkeeping benefit, operating profit rose 13 per cent.

L&G's institutional business has become increasingly important in driving profitability. It has been taking advantage of the growing market for pension scheme buy-ins and buyouts, insuring against or fully taking on the liabilities of pension schemes. It completed £3.9bn of such transactions last year, up from £3.7bn in 2016. The overall UK market was estimated to have risen to £12bn in 2017, up from £10.4bn in the previous year.

There remains plenty of potential for these transactions to increase. The Office for National Statistics reckons that, in total, defined-benefit schemes in the UK's private sector have aggregate liabilities of about £2.3 trillion, but so far only about 7 per cent of those schemes have insured their future payouts. 

Such business is also making progress overseas, particularly in the US, where in 2017 L&G completed 15 'bulk' deals, totalling $713m (£514m) in premiums, up more than half on the previous year. Admittedly, income from these types of transaction, where pension scheme trustees buy bulk annuities for their members, can be lumpy, given their large size. But management says it was quoting on around £17bn of buy-ins and buyouts in March. 

On the retail side, sales of individual annuities have been dull since the introduction of pension freedom reforms in 2015. L&G wrote £671m in individual annuity premiums last year, up more than three-quarters on 2016, underpinned by its highest volume since 2014. However, that compared with £1.3bn in sales in 2013.

Strengthening demand from external pension schemes for Legal's range of products also bolstered inflows into its investment management arm. It gained £43.5bn in net external inflows last year, primarily into its ‘Solutions’ product, representing 5 per cent organic growth. That included record international inflows of £33bn, following expansion of its overseas distribution network, which included establishing trading and index fund management operations in Hong Kong and securing its first Australian client. Together with market returns, that took assets under management to £983bn.  

Its direct investment business has also benefited from recycling its more mature assets, generating gross proceeds of £369m, ahead of management's £250m target. The value of its direct investments increased by more than a quarter to £1.45bn.

LEGAL & GENERAL (LGEN)   
ORD PRICE:273pMARKET VALUE:£16.3bn
TOUCH:272.9-273p12-MONTH HIGH:288pLOW: 249p
FW DIVIDEND YIELD:6.4%FW PE RATIO:8
NET ASSET VALUE:132pSOLVENCY II RATIO:180%
Year to 31 DecGross premiums (£bn)Pre-tax profit (£bn)Earnings per share (p)Dividend per share (p)
20156.321.3518.213.4
20166.631.5821.114.4
20176.961.9831.715.4
2018*7.312.0528.016.4
2019*7.682.6035.617.6
% change+5+27+27+7
Normal market size:7,500   
Matched bargain trading    
Beta:0.67   
*JPMorgan Cazenove forecasts (adjusted profits and EPS)