Prudential should prove resilient

Prudential plc – not to be confused with US insurance firm Prudential Financial – has two focuses. The first and most important is PruAsia, which accounted for just over half of underlying profit last year. The insurance and asset management arm sells a wide range of life and health insurance and retirement income products across a wide array of Asian countries. Prudential itself describes this as a “resilient and compounding business”, and it’s not hard to see why.

Since 2009, its reported operating profits and free surplus cash generation have grown at a compound  average rate of 18 and 21 per cent a year, respectively. Income is comprised of both renewed premiums and new business, the latter being driven by the rapid expansion of an ageing and under-insured middle class whose wealth is largely concentrated in low-interest deposit accounts. It’s not unreasonable to assume that the pandemic may boost the demand for products offering greater financial security, as well as life and health policies.

The second arm is Jackson, a US-focused writer of variable annuities and other retirement savings products. While slower growing, it is highly cash-generative and in 2019 posted an operating profit of $3.1bn (£2.5bn) before charges for short-term movements in interest rates and equity hedging positions. It was a conservative approach to hedging that helped Jackson ultimately take market share in the last major financial crisis in 2008.

In theory, this conglomerate model should benefit from economies of scale. But the geographical spread of Prudential’s subsidiaries offers limited opportunities for cross-selling and brand recognition. This was one of several reasons why shareholder and activist hedge fund Third Point wrote to the group’s board in February to press for a spin-off of Jackson. Within weeks, Prudential acquiesced, confirming that plans for a minority initial public offering of the division had begun.

To analysts at RBC, a separate listing gives Prudential the chance to “unlock” a conglomerate discount of 22 per cent, based on a sum-of-the-parts valuation of the subsidiaries. Investors should not expect any imminent moves on this front – while management has promised an update in August, the current operating environment does not lend itself well to a stock market listing of a complex insurance division. It is also unclear how much capital Jackson will need as a standalone entity. But when the listing does happen, RBC believes PruAsia could command a rating of around 14 times forward earnings. That would be in line with Asian peer AIA, and double the current trading multiple. Jackson rivals trade at depressed low-to-mid-single-digit multiples of earnings.

We also believe that recent selling pressure has masked the strength of Prudential’s capital base. Following last year’s spin-off of M&G, Prudential is free from tough European insurance rules for holding surplus capital. As a result, the LCSM ratio in the table below – which refers to Hong Kong rules for calculating capital – reflects a surplus of $9.5bn, as much as $2.9bn above regulatory constraints. Although this will have been dented by recent swings in equity markets, interest rates and credit spreads, Jackson’s risk-based capital ratios were broadly unchanged at the end of March.

Prudential has other shrewd backers aside from activists. Its shares are the most prominent 'best idea' holding of the top-performing UK sustainable investment funds tracked on our new Ideas Farm pages. That's despite a “moderate controversy” rating from ESG data provider Sustainalytics. This suggest appetite for the shares can ride another important mega-trend aside from Asia's growing middle class.