PRS - Prudential Financial Stock: Undervaluation And Strong Dividend Yield

2023-11-03 14:17:29 ET

Summary

• Prudential Financial, a $33-billion market-cap financial services company, has released its financials for Q3 FY2023. Let's dive in.
• Despite a net loss in the third quarter, Prudential shows a strong recovery for the nine months of 2023, with a net income of $1.17 billion.
• They launched Prismic, a life and annuity reinsurance company, to drive long-term growth and reduce market sensitivity.
• In my view, PRU's fair value per share lies above $100. The company has a generous total shareholder return and is cheaply priced below 8x of next-year EPS.
• So I reiterate my 'Buy' rating today.

Today I'm updating my coverage of Prudential Financial ( PRU ), a financial services company with a market capitalization of $33 billion that oversees ~$1.361 trillion in assets as of September 30, 2023. The company has just released its financials for Q3 FY2023 , and since my last bullish call the stock has gained >10% in total returns (vs. S&P 500 return of 0.76%), so I imagine that investors in PRU will be very interested to know what has happened to the company over the past few months.

In case you're new to the company, Prudential is a global financial services company with operations in the United States, Asia, Europe, and Latin America. It offers a wide range of financial solutions, including life insurance, annuities, retirement options, mutual funds, and investment management, serving both individual and institutional clients. Prudential boasts an extensive distribution network in the financial services industry.

Prudential's main operations can be broken down into different parts, according to the 10-Q:

1. PGIM: This is their global investment management business.

2. U.S. Businesses: This segment includes Retirement Strategies, Group Insurance, and Individual Life businesses operating in the United States.

3. International Businesses: These are operations outside of the United States.

4. Closed Block division: This part of the company is treated as a divested business, meaning it's separated from the rest. It might involve businesses that have been sold or are in the process of being closed down.

5. Corporate and Other Operations: This category includes corporate-related activities and initiatives that aren't specifically linked to the other business segments, along with the Divested and Run-off Businesses mentioned earlier.

When you look at the summary of the company's latest results, an investor may have mixed feelings: In the third quarter, the net loss nearly multiplied by nine, but for the nine months of 2023, PRU shows a strong recovery from a net loss of $1.6 billion last year to a net income of $1.17 billion this year.

The loss acceleration it saw in Q3 was mainly attributed to a whopping $1,248 million in unfavorable investment losses and another $193 million due to changes in market risk benefits (net of related hedging gains). But the reversal it saw for 9M FY2023 was thanks to a $2,515 million boost from investment gains and related adjustments, a $912 million benefit from market risk, and a $411 million increase in adjusted operating income from business segments.

The PGIM segment saw a slight decrease due to higher compensation expenses, while Retirement Strategies increased with higher net investment spread results. Group Insurance improved in Q3 FY2023 due to higher underwriting results, and Individual Life increased due to higher net investment spread results and lower expenses. International Businesses improved in the quarter despite unfavorable currency exchange rates, mainly due to higher net investment spread and underwriting results.

During the earnings call , Prudential's management emphasized their continued strategic progress and financial strength, aiming to become a higher-growth, less market-sensitive, and more nimble company. They launched Prismic, a life and annuity reinsurance company, to drive long-term growth and reduce market sensitivity. Prismic is also expected to expand PGIM's assets under management.

The company highlighted its commitment to enhancing customer service and experience through various technology partnerships, including Enrolify and Evolution IQ, which streamline the enrollment process and disability claims. Prudential also showcased its growth in various markets, with record sales in Brazil, strong performance in the U.S. individual retirement sector, and new strategic relationships with partners like LPL Financial.

In Q3 FY2023 PRU returned ~$711 million of capital to shareholders (~2.15% of total market cap for just 1 quarter), including share repurchases of ~$250 million and dividends of ~$461 million. The dividend yield is currently at 5.42% [TTM], and in the next few years, PRU will likely continue to increase the payout, as it has done for the past 15 years. Wall Street analysts forecast that the dividend yield will rise to nearly 6% by FY2025, which looks very good, assuming that the current tight Fed policy eventually shifts to a soft policy and interest rates creep lower.

Overall, PRU's business seems to me to be quite resilient, and recent initiatives aimed at growth and partial de-cyclization should help the company continue its recovery. But what about valuation?

The Valuation

As I mentioned last time, PRU stock is trading well below its longer-term price-to-earnings ratio and is still pricing in a sharp P/E contraction next year:

And this apparent undervaluation (the discount in the implied P/E ratio compared with the long-term average multiple) should persist in the next few years if we look at analysts' forecasts:

However, although PRU is relatively inexpensive by its historical standards, it remains expensive in its industry. To demonstrate that I'll be using the following peer group to figure out PRU's relative valuation:

Source: Author's compilation, Seeking Alpha data

Looking at TBV/MC, PRU looks like the most expensive stock compared to its peers:

However, if we look directly at the earnings-related valuation - as far as I know, investors buy shares for the sake of earnings and the resulting shareholder return, so it's important - it turns out that PRU is not that expensive even compared to its peers:

Argus Research analysts issued a price target for PRU of about $102 per share in August of this year [proprietary source], stating that the company's focus on the faster-growing international life insurance markets would enable it to generate industry-leading returns. However, if we assume that PRU does indeed deliver adjusted earnings per share of $13.23 in FY2024, then with the multiple potentially rising to 9 times earnings, PRU stock should trade at $119 (based on my calculations), which is nearly 30% above today's price.

The Bottom Line

Of course, investing in Prudential Financial stock carries several risks - here's just a little list of them:

• market risk, which is influenced by economic conditions and can lead to investment losses;
• credit risk due to investments in debt securities that might default;
• operational risk encompassing fraud or technology failures;
• regulatory risk from potential changes in regulations impacting PRU's operations, and
• competitive risk as it competes in a crowded financial services market.

Despite these risks, I think PRU looks like a fairly cheap representative of its industry in terms of its price-to-earnings forward ratio, while offering a fairly generous dividend yield and total shareholder returns. I think the fair price for PRU lies above $100 per share, and this assumption leads me to reiterate my 'Buy' rating today.

Thanks for reading!

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