Prudential Stays at Neutral - Analyst Blog
September 23 2011 - 8:45AM
Zacks
We are maintaining our Neutral recommendation on the shares of
Prudential Financial Inc.
(PRU).
Prudential is the second-biggest U.S. life insurer and has one
of the best collections of businesses in the U.S. life insurance
sector, with strong positions in high margin businesses and a
significant diversification. Though there was a drag on revenues
recently (for the past couple of years) due to the volatile
economic environment, the company has consistently increased its
revenues over the past several quarters.
Prudential has a strong international presence that provides it
with better organic growth opportunities than its peers. Revenue
from its international business accounted for approximately 40% of
2010 net income.
Prudential has a strong footprint in Japan, with operations in
the region for over thirty years. Japan is a market that continues
to present attractive opportunities for Prudential to build on
success in protection products and increasingly address retirement
needs. The recent acquisition of Japan-based Star Edison has
broadened the company’s distribution, increased its operation
scale, and expanded the client base by roughly 50%.
Management anticipates this acquisition to be accretive to
return on equity and earning per share based on the value of the
in-force acquired and the expense synergies likely to be achieved
after integration. Management also believes that the acquisition
will pull the group’s ROE to above 12% in 2012 and above 15% in
2015. With this acquisition, Prudential would be the largest
foreign life insurance company in Japan based on in-force life
insurance.
Prudential has also announced a 50: 50 joint venture with
China-based Fosun Group in a $78 million deal. The company is
eyeing the fast growing Chinese life insurance market that has
expanded at an average of 30% a year over the past three decades.
Since the insurance penetration is still far below the average
levels in the Chinese market, it looks promising to Prudential. It
is being projected that the Chinese insurance market will grow at
an annual growth rate of 10–15% for the next five years.
Prudential has been focusing closely on three areas – Asset
Management, Annuities and International –, and as such has axed
other allied businesses such as health care, property and casualty,
retail brokerage, investment banking and commodities. Management
expects to generate ROE of 13% to 14% by 2013 by disposing less
profitable businesses that have been dragging the overall return.
ROE in first half of 2011 was 11%.
However, we hold a cautious near-term outlook on
Prudential’s U.S. insurance business, given the weak economy and
high competition. We expect the overall production from the
business to be modest for the next few quarters.
The Individual Life business within the U.S. insurance business
is expected to see weak sales, primarily due to price increases
implemented over the last year. A weak economy will also keep sales
under pressure.
In the Group Insurance business, we expect near-term results to
be suppressed by high unemployment, limited wage inflation and
intense competition. Although the current environment is
challenging, we expect Prudential to generate mid to high-single
digit growth in its group insurance business over time.
Moreover, Prudential’s investment portfolio remains a source of
threat because of its high exposure to commercial real estate,
through CML and CMBS, hedge funds, partnerships etc. Moreover, the
ongoing low interest rates will pressure net investment income,
thus making it difficult for the insurer to keep pace with the
obligation that they have accumulated on high sales of annuities
and life policies over the past few years.
Coming back, we are positive about Prudential’s effective
capital management. Prudential initiated a $1.5 billion share
repurchase program in June 2011 for the first time since 2007; it
will last through mid 2012. With an excess capital of $2.2–$2.7
billion in hand, we foresee an active capital management through
share repurchases, even if management targets to maintain $1
billion of liquidity at the parent company. With so much of free
cash available, Prudential has the capacity to execute an accretive
acquisition, leading to inorganic growth. We also believe the
company is in a position to participate in the consolidation of the
global life insurance and retirement market.
A right mix of business and strong fundamentals has helped
Prudential garner market share from weakened competitors. Moreover,
Prudential is poised to improve its earnings faster than its peers
– Metlife Inc. (MET), and
American International Group Inc.
(AIG) – in the upcoming years.
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