LGGNY - Legal & General: Attractive Dividend And Valuation

2023-06-27 04:40:33 ET

Summary

• Legal & General's share price has been drifting south, resulting in an attractive yield of 8.6%.
• The company has a solid business trajectory, focusing on retirement and pension products, and strong dividend prospects.
• Despite recent lackluster share price performance, the current valuation is seen as a bargain with potential for both dividend income and share price appreciation.

U.K. based financial services group Legal & General ( OTCPK:LGGNY ) has seen its share price drifting south lately, meaning it now has a yield of 8.6%. I regard that as attractive, rate the shares a "buy" (as I did in my most recent piece last September 2022, Legal & General Remains A Solid Long-Term Income Pick ) and have indeed recently bought into the company again after last owning the shares several years ago.

Solid Business Trajectory

Legal & General has reoriented its business in recent years, mostly pulling out of its historical heartland of insurance and focussing on retirement and pension products.

I continue to think the company has huge strengths, especially its brand and reputation and existing customer base of over 10m. Pensions seems like a solidly reliable space to be in in the long term, with a huge market, large customer spend, switching costs for customers and attractive profit margins. Last year, for example, Legal & General's post-tax net profit margin came in at 16.7%.

The business is a well-oiled machine I expect to keep doing well for the long term. The company struck a buoyant note in its final results, noting that "We start 2023 in good shape and looking forward to achieving many goals which build on last year's successes".

Strong Dividend Prospects

I previously discussed the firm's dividend history extensively in my 2020 piece Legal & General: Good Yield For A Little-Loved Business .

Now as then, several points stand out. In general, the company has a good track record of raising dividends. When trouble hits, be it the financial crisis or pandemic, that can take a hit. But the long-term story is one of growth. Indeed, the company sets out in its 2020 five-year dividend strategy an ambition of annual dividend growth at low to mid-single percentage digits and earnings per share growth above dividends.

Dividend growth of 5% annually in recent years has delivered on that expectation and I think that level of raise is a reasonable expectation for shareholders until 2024 (when the current strategy expires) but also likely beyond.

As of the end of last year, the company remains impressively on track to hit its five-year capital return plans

The company has slightly reduced the weighted average number of shares over the past five years.

Earnings per share last year came in at 38.3p. That means the dividend of 19.4p per share) was covered almost twice over by earnings. That was the strongest coverage level of recent years, but the firm has consistently more than covered its dividend from earnings. I see no reason to expect a dividend cut in the absence of an external shock such as a financial crisis, in which case it could be at risk.

Attractive valuation

Last year's aggregate earnings were £2.3bn. I find that pretty exciting for a company with a market capitalisation of £13.5bn. It means the shares trade on a price-to-earnings ratio of under six. For a long-established FTSE 100 member with a large customer base and iconic brand, I see that as an absolute bargain.

That said, Legal & General has often looked like a bargain in recent years but the share price performance has still been lacklustre. Over one year, it has fallen 5% and over five years, the fall has been 16%.

My motivation to buy here was the yield, so the share price fall does not bother me for now. Longer term, though, I would prefer shares I own at least to hold their value if not to gain. Why has Legal & General failed to do so and does it presage more of the same in future, or just mean that today's price could be a bargain in terms of capital appreciation potential as well as income?

The answer, I think, lies mostly in terms of investing trends. U.K. shares are cheap now as they seem broadly out of favour with many investors. Within that, financial services shares look particularly cheap. Investment managers have seen their prices battered amid fears that returns will be weak in coming years as UK investors' willingness to invest may fall due to straitened household budgets.

Realistically, I think the long-term risk outlook for Legal & General is fairly benign. I therefore see its current valuation as a bargain. Not only am I hoping to generate a sizeable and growing dividend stream from my investment, I am also hopeful of some share price appreciation in coming years.

Accordingly, I maintain my "buy" rating on the name.

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