MGPUF - M&G: A Compelling Asset Manager With A 10% Yield

2023-05-16 06:12:04 ET

Summary

• M&G plc is a UK-based company that offers savings and investment services to retail and institutional customers worldwide.
• M&G is generating a substantial level of capital and should continue to do so, allowing the business to grow its distributions (10% dividend yield currently).
• Management is investing in growing its Asset Management and Advisory businesses, leveraging its key expertise.
• The company represents a compelling takeover target and has attracted large-scale investors in the last year.
• At its current valuation, the business looks undervalued relative to its peers.

Investment thesis

Our current investment thesis is:

• M&G has a strong base on which to build a quality business. It has a longstanding brand, a track record of outperformance across its funds, and deep expertise across many industries/asset classes.
• Management has big plans to transform the business, investing in modernizing and expanding its current operations. This has yet to yield AUMA gains, but we do see improvement, such as in Wealth.
• Its heritage business is supporting capital generation, allowing the business to support market-leading distributions.
• Given these factors and its current size, the business represents an attractive takeover target.

Company description

M&G plc ( MGPUF ) is a UK-based company that offers savings and investment services to retail and institutional customers worldwide. The company has two operating segments: Asset Management and Retail and Savings.

Its products include retirement, savings, and investment management solutions, individual and corporate pensions, annuities, life, savings, and investment products.

The company was formerly known as M&G Prudential plc and was subsequently spun off from Prudential plc ( PUK ).

Share price

M&G's share price has traded sideways since its listing in 2019, but this is an unfair assessment given the global situation. The company was negatively impacted by the initial Covid lockdowns, followed by a positive impact as markets remained resilient, followed by difficulties as we entered a bear market.

Financial analysis

Presented above is M&G's financial performance for the last 4 years.

Revenue

M&G's revenue can be considered in 3 different segments, Asset Management, Retail & Savings, and Other (Which are primarily short-term fluctuations in investment returns).

As mentioned, the company has been punished by timing, with its financial results primarily reflecting a period of difficult market conditions.

In order to assess the business, we will consider its segments in detail.

Asset Management

M&G has been managing money in the UK for almost 100 years, developing a long history of value creation for its clients. M&G currently has an AUMA of £303bn, diversified by source globally.

The diversification of AUMA reflects the company's deep expertise in several industries, as well as its international draw. With a substantial amount of its assets derived from institutional and internal investors, its AUMA in/outflows should be less volatile than other AMs.

M&G has achieved this growth by outperforming its peers and thus displaying its capabilities. Generating superior inflows, which are key to driving returns through fees, is dependent on selling the market on your ability to outperform. As the following graphs show, M&G is a top performer relative to other funds. This data will be used for capital allocation decision-making.

M&G's position in the UK market gives the business an impressive base from which to generate growth. The company is a leading AM in many traditional investing strategies, giving the business scope for continued growth as the UK develops over time.

The company has focused on developing its international business, seeking to tap into AUM growth in regions such as Asia, where rapid economic development is increasing demand for investing services. Our view is that AUMA growth will likely come from these regions given the superior economic development, however, Europe should not be neglected. Investing in Europe is not developed and as widespread as it is in the US, for example, representing scope for improvement.

Further, the business has been expanding its private asset base, which is an area of growth globally as investors seek strategies to outperform traditional equities. The graph below illustrates the significant outperformance forecast for private assets. This segment is attractive for this growth, but also because it generally comes with greater margins, due to the additional complexity.

M&G already has sufficient capabilities in this field, with a strong European and Global rating. This should allow the business to partake in a lucrative share of the asset flows into this segment.

ESG considerations are becoming an important factor for Asset Managers, with an increasing demand for ESG funds and investments. This is driven by both legislation and changes in consumer trends, pressuring AMs to develop the necessary capabilities to meet these changing mandates. As the below graph (left) illustrates, M&G's forecast growth in this market is substantial. For this reason, M&G has invested heavily in developing a strong market offering.

The benefits for M&G are not just growth but resilience. As the above graph (right) reflects, sustainable funds are seeing positive net flows despite weaker market conditions, suggesting we will see a period of unwavering demand for the service.

M&G has been rapidly scaling its offering, including conducting M&A, as a means of showing the market it is a serious player.

Despite the slight decline in AUMA, M&G's AM business has generated revenue growth in FY22. This was driven in part by the resilience of its private asset investments, which experienced growth in both segments. It should be noted that the private asset industry generally experiences a "lag", with assets marked-to-market due to the lack of free market pricing.

Overall, we like M&G AM operations. It is built on a strong brand name, which is synonymous with deep expertise. Expanding overseas and developing in Private markets and ESG should help the business achieve healthy AUMA growth in the coming years.

Wealth

Wealth is currently the larger of the two segments, offering financial advice and related services to clients.

This is a segment that has experienced a small transformation in recent years, driven by a change in industry dynamics. We have seen the rise of robo-investors, digitalization of the industry, and greater knowledging of investing, contributing to many "going it alone". This has pressured Wealth Advisors to innovate and develop their offering to meet the changing market needs.

M&G has broadened its offering through acquisitions, as well as internal development of its services, utilizing both its own and independent advisors. The largest expansion is likely an increase in advice work, with a DTC offering.

AM and Wealth are complementary offerings as they allow for cross-selling opportunities between the segments. Further, it creates a closed loop of expertise which provides confidence to clients that they are receiving an all-encompassing service.

M&G illustrates its Wealth segment with the following.

Management is still on the development journey, with the near-term goal to have all PruFund solutions on its platform, which increases the availability to advisers to recommend.

From a financial perspective, this segment of the business has generated strong returns, leading to improved net flows. Given the successive periods of negative net flows, it is too early to suggest the return to growth is certain, but this looks to be performance-driven, which gives us confidence.

Heritage

Finally, comes Heritage, which given its nature is included with Wealth.

The Heritage business is an insurance operation, which holds shareholder-backed annuities and with-profits funds. Given the greater certainty around this segment, and its size relative to the rest of the group, M&G has good visibility as to its capital generation. Management estimates this segment will generate £12bn over its lifetime, representing 2.6x its current market value.

The majority of the assets held are investment grade and secured, reducing the risk of default (no defaults experienced in the most recent period) and material changes to underlying assumptions, impacting future cash flows.

In the most recent period, returns continue to be strong, with Management reiterating its target total cash generation of £2.5bn (more than 50% of market cap) by 2024 (£0.8bn achieved).

AUM

Despite the positive developments and outlook for the business, it is not currently translating into positive results from an AUMA perspective. Although the net client flows in FY21 were strong, this was fairly disappointing in FY22, despite the weaker market conditions.

It is key for M&G to illustrate its progress with consistent AUMA growth, otherwise faces a decline in investor sentiment.

Economic considerations

Current economic conditions represent a key risk for the business. With inflation running rampant, we have seen interest rates lifted as a response. This has increased the cost of capital, as investors now have access to a far more attractive "risk-free rate". This encourages investors to pull their invested capital and seek more attractive returns. This is likely a partial reason for the net redemptions in FY22.

Further, current economic conditions are contributing to a slowdown in both public and private markets, which reduces the interest in investing activities. If investors fear that markets will decline greater than inflation, their perceived value is in cash or short-dated bonds.

Margin

M&G has seen its margins decline moderately, due in part to the fall in fees earned as a degree of costs will always be fixed. Management is targeting a CIR of 70% by FY25, which when considering FY20, looks more than achievable. Our view would be that the business target a lower level than this, implying that a mean reversion should not be the minimum achievable.

Management is also seeking to achieve cost savings of c.£200m in the coming years, which should support margin improvement. As the company grows its AM business, its margins will be more heavily scrutinized.

Quarterly results

Judging M&G's results is an incredibly difficult task as it must hedge its Solvency II position, contributing to some wild results Y/Y. Our position, as investors who are very particular about numbers stacking up, is to not focus on the numbers. We jest but investors will need to dig deeper than headline numbers or quarterly results.

Valuation

M&G is currently trading at 9.5x its NTM earnings, with a dividend yield of 10%. Given the capital generation outlook, dividends are sustainable in the near term, with Management reiterating it is targeting growth.

Relative to its peers, this looks quite attractive. Schroders ( SHNWF ) is trading at 14x earnings, Phoenix at 9x, and St. James's Place ( STJPF ) at 15x.

With its AM business currently underperforming, we would suggest a discount of c.20% is appropriate to Schroders and SJP. This implies an upside of 22%, with the downside protection of large distributions.

Takeover Target & Recent Investments

Rumors have been circulating that M&G may be a takeover target for Macquarie Group Ltd. ( MCQEF ), the Australian Investment Bank. This looks to be a reasonable development as although there is significant potential with the business, execution has lagged. The touted valuation is >£5bn, which would imply a minimum upside of 9%.

A takeover looks to be a reasonable long-term target, as M&G remains a small player in a market that has consolidated. With passive funds continuing to take market share due to their low-cost profile, the pressure is on AMs & Wealth advisors to cut costs and offer a more compelling proposition. With cost efficiencies, M&G can utilize its expertise to generate impressive returns.

These takeover rumors are described as "speculation" but we believe it is inevitable, be it this year or in the future.

In addition to this, M&G's shares have bought up several large funds recently, including the Kingdom Holding Company (Saudi Arabia). This suggests a change in the long-term sentiment of the business, and potentially an expectation that the business will be sold.

Final thoughts

M&G has the foundations of what could be a fantastic business. It has a large and diversified asset/client base, deep expertise, and a brand with heritage. The last few years have been difficult but that is expected given the circumstances. The fundamental cash generation remains strong and will support the company's growth efforts.

Management has promised a lot in the coming years, which we are hesitant to price in, yet in our view, the downside is protected. With strong capital generation, M&G will continue to support its high distributions, with a long runway for unwinding this. The potential for a takeover is interesting and we concur that given the company's size, it may be better off as part of a larger group.

Regardless of the medium term, we see asymmetric returns with strong distributions, and an undervalued stock price.

For further details see:

M&G: A Compelling Asset Manager With A 10% Yield