LGGNY - Prudential Is Great But Buy These 6.5+% Yielding Blue-Chips Today

2023-06-22 07:30:00 ET

Summary

• The economy is holding up better than expected, with a recession predicted to begin in Q1 2024.
• Prudential is a strong, well-positioned company with a 6% yield and a 2.6% risk of a cut in a severe recession.
• But PRU's growth outlook is less than 4% and at the moment it looks like most ETFs will be able to outperform long term.
• Two higher-yielding A-rated blue-chips are no-brainer buys.
• One yields a safe 8% and offers 2X the return potential of PRU. The other yields 6.5% and is 51% undervalued, offering almost 40% annual return potential for the next few years.

This article was published on Dividend Kings on Wed, June 21st.

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The good news is the economy is doing fine for now.

In fact, it's holding up far better than almost anyone expected at the start of the year.

The Atlanta Fed thinks the economy in Q2 is holding up better than expected, likely pushing off the recession into Q3 or even later.

David Rosenberg predicts that a recession will likely begin in the first quarter of 2024. He bases this prediction on a number of factors, including the following:

• The yield curve has been inverted, which is a historical indicator of recessions.
• The Federal Reserve is raising interest rates, which could slow economic growth.
• The US economy is facing a number of headwinds, including rising inflation and a potential trade war with China.

However, it is important to note that this is just a prediction, and it is impossible to say for sure when a recession will occur. The economy is complex, and many factors can affect its future course.

Here are some additional thoughts on the article:

• I agree with the author that the yield curve inversion is concerning. However, it is important to note that the yield curve has inverted before without leading to a recession.
• I also agree that the Federal Reserve's interest rate hikes could slow economic growth. However, the Fed is raising rates in an effort to prevent inflation from getting out of control.
• I am less convinced by the author's argument about the US economy facing a number of headwinds. While there are some challenges facing the economy, there are also some positive signs, such as low unemployment and strong consumer spending." - Bard

This is now consistent with the bond market and Bank of America, both who think a recession is likely to begin in Q1 2024.

Now not everyone agrees of course. NDD, the premier economic guru on Seeking Alpha, who monitors dozens of real-time weekly economic metrics, estimates that a recession is mostly like by the end of November 2023.

Why is the "waiting for Godot" recession taking so long? Two main reasons.

First, $2.5 to $4 trillion in excess savings from the Pandemic have still not been spent. Americans have been spending this down for years and estimates range from the end of 2023 to mid 2024 for when they will be exhausted.

• the yield curve inverted on October 31st 2022 and the historical lag to recession is 8 to 21 months
• a historical recession is likely between June 31st 2023 and July 31st 2024

When people say "there is no recession yet, so one isn't coming" they are unaware that there is plenty of time for the expected downturn to arrive.

What about the Fed? The one who has caused 9 of the last 12 recessions through rate hikes?

The real interest rate right now is...1%.

• 5% Fed funds rate - 4% CPI

According to over 400 economists at the Fed, 0% to 1% real rates are "neutral".

So we are likely just modestly restrictive now, 15 months into the most extreme rate hiking cycle in 42 years.

If the Fed were to keep rates at 5% through April, as some FOMC members want, it would increase real rates to 3% and if the Fed follows through with its planned hikes, that would be a 3.5% real interest rate, up from 1% today.

This is not speculation, this is simple math, created by -$300 billion in reverse money printing by the government for the rest of this year.

Sucking money out of the economy at that rate, while maintaining rates at current levels, is almost certain to create a recession.

Which brings me to today's update on Prudential ( PRU ).

Several Dividend Kings members have asked me to provide an update for Prudential ahead of the recession.

Let me show you why Prudential is a potentially great high-yield dividend growth blue-chip.

But why Legal & General ( LGGNY ) and Truist Financial ( TFC ) are potentially better buys today, ahead of the most anticipated recession in history.

Prudential: Well Positioned For This Recession

Prudential Should Successfully Navigate the Challenging Macro Environment in 2023... We like the company’s progress with regard to its 2019 cost-saving initiative, as it's expected to achieve its target of $750 million of run-rate savings ahead of schedule." - Morningstar

What makes Prudential a potentially great long-term investment?

Let's start with the fact that this is a company that was founded in 1875, and over the last 148 years, it has survived and thrived through:

• 29 recessions
• 7 depressions
• 7 killer pandemics (one that killed 5% of humanity
• over 27 bear markets
• interest rates as high as 20%
• inflation as high as 22%

Prudential is built to last and will likely outlive us all.

And Prudential has a plan for survival and thriving for decades to come.

The company’s strategy is to transform itself into a higher-growth, less-market sensitive, and more nimble business by reallocating capital to increase earnings contribution from higher-growth businesses like group insurance and investment management and reducing the earnings contribution from individual annuities business." - Morningstar

PRU is focused on the fastest-growing parts of its most profitable businesses, and that doesn't necessarily mean it's a fast-growing company (more on this soon).

But before we talk about what kind of growth PRU investors might achieve, let's first talk about the fundamental risk of the company going to zero.

Prudential Consensus Credit Ratings

(Sources: S&P, Fitch, Moody's, AM best)

There is a 1 in 63 chance of losing all your money buying PRU today.

Or was it the last time the rating agencies did their annual updates?

The Bond Market Isn't Worried About Prudential

The bond market is currently pricing in a 4.35% chance of PRU going out of business within 30 years. And that risk is up 17% in the last six months.

But the recession is coming within one year, according to the bond market, and the default risk in that time is 0.52%, up 93% in the last six months.

My goodness, bankruptcy risk doubled in six months?! That sounds terrifying.

But for context, according to Goldman Sachs, the risk of nuclear war with Russia is 2.5%, or 5X higher than the risk of Prudential going bust in this recession.

Ok, so PRU is a strong, balance sheep company with management claiming to have a bright growth plan.

It's a safe company to own, and it yields 6%.

But how safe is that dividend?

2.6% Risk That Prudential Cuts Its Dividend In A Severe Recession

The preponderance of evidence indicates the recession will be mild, between -0.5 and -1.5% GDP decline. But not everyone agrees.

Deutsche Bank, which recently said that a recession is a " virtual 100% certainty ," thinks the recession is going to be a 6% GDP decline. In fact, Deutsche Bank says that for the US to avoid a recession at this point would be "historically unprecedented."

How bad would that be if true?

The Great Recession caused 8 million job losses, and a 57% stock market crash, the 2nd largest in US history, was a 4% GDP decline.

A 6% GDP decline would be 2nd only to the 9% GDP decline during the Pandemic.

Of course, this is the extreme case, caused by what Deutsche Bank thinks could be loan losses rising from 4% today to 11% due to the highest interest rates in 20 years.

But this is where the 75% safety of Prudential's dividend comes in.

• 75% safety score on the DK 250-point safety model
• 1% risk of a dividend cut in an average recession
• 2.6% chance in a severe recession

According to rating agencies, PRU has a 41% payout ratio compared to 50% or less safe.

If it hit a severe recession, PRU's earnings could fall 60%, and earnings would still cover the dividend.

In the Great Recession, when PRU was exposed to lots of subprime mortgages, earnings fell 65%, and the Fed required them to cut their dividend. EPS fell 13% in the pandemic and 35% in 2022, when the Pandemic life insurance policies really hit it.

Even if PRU's payout ratio were to surpass 100%, it could borrow against its A-rated balance sheet to cover a modest payout gap for a year or two.

PRU's dividend is expected to grow 4% in the recession and 4% the year after.

This is a 6% yield you can trust.

Good Company At A Great Price

• DK rating: 67% medium risk 9/13 blue-chip
• current price: $85.39
• fair value: $110.34
• discount: 23%
• yield: 5.9%
• growth consensus: 3.7%
• total return potential: 9.6%

PRU offers 20% annual Buffett-like returns through 2025.

The only reason I'm not pounding the table on PRU today is that for the moment, the growth outlook has dipped so low the return potential is under 10% over the long-term.

Should that growth outlook rise to 6%, its growth since over the last 16 years, then you're looking at a solid 12% return potential from Prudential.

Legal & General: Better Yield + Better Growth + No Dividend Taxes

Further Reading

• An Update On Legal & General: It's Still Attractive

What Makes Legal & General A Good Buy Today

LGGNY sold its insurance business to Allianz in 2019 and is now a pure-play UK asset manager with an A-credit rating.

The bond market is pricing in a 2.25% 30-year bankruptcy risk and just 0.3% during the recession (the UK is already in one).

LGGNY's fundamental risk is slightly less than PRU's and has been dead steady for the last 6 months compared to 93% increase in 12-month default risk for PRU.

Fundamental Summary

• DK quality score: 72% low risk 10/13 Blue-Chip
• DK safety score: 70% very safe dividend (3% dividend cut risk in severe recession)
• Historical fair value: $23.10
• Current price: $14.67
• Discount to fair value: 36%
• DK rating: potential strong buy
• Yield: 7.8%
• Long-term growth consensus: 5.2%
• Consensus long-term return potential: 13.0%.

Twice the total return potential of Prudential, an incredible 37% annually!

Truist Financial: Crazy, Stupid, Cheap A-rated Ultra-Yield Blue-Chip

Further Reading

• Truist Financial: A 7% Yielding 53% Undervalued Blue-Chip With 250% Upside Potential

Why Truist Is A Fantastic Buy Right Now

How safe is TFC? It's about as fundamentally safe as prudential.

(Sources: S&P, Fitch, Moody's)

But TFC also yields 1% more than PRU, a nice juice 6.6%. And guess what? It's growing nearly twice as fast, 6.4% annually.

That's 13% long-term return potential, matching LGGNY and about 3% more than PRU.

• 143% higher 30-year inflation-adjusted return potential

Nothing against Prudential, but this is some very simple spreadsheet math.

Fundamental Summary

• DK quality score: 63% low risk 10/13 blue-chip
• DK safety score: 70% very safe dividend (3% dividend cut risk in severe recession)
• Historical fair value: $64.66
• Current price: $31.50
• Discount to fair value: 51%
• DK rating: potential ultra value buy
• Yield: 6.6%
• Long-term growth consensus: 6.4%
• Consensus long-term return potential: 13.0%.

39% annual return potential through 2025, that's not Buffett-like; that's Joel Greenblatt returns.

• 40% annually for 21 years

Bottom Line: Prudential Is Great, But Buy These 6.5+% Yielding Blue-Chips Today

I have nothing against Prudential. It's a great A-rated ultra-yield blue-chip that is likely to maintain a safe dividend even in a severe recession worse than the GFC.

Which is not likely coming.

However, you have to make tough choices unless you're the Swiss Central bank and can print money to buy stocks.

Legal & General is an A-rated asset manager growing 2% faster than PRU and offering twice the return potential over the next 2.5 years.

All while offering a nearly 2% higher yield. A yield with no dividend withholding taxes.

And Truist? It's one of the best blue-chip bargains on Wall Street.

America's 7th largest bank, with an A-credit rating, and take a look at the bond market's fundamental risk estimates!

The price has fallen off a cliff, falling 50% at one point, while the bond market, the "smart money" on Wall Street, is saying the fundamental risk didn't move...at all...in the last six months...even with the regional banking crisis!

Are you looking to earn 6.5% to 8%? Do you want deep value A-rated balance sheet quality? Do you want to sleep well at night while potentially earning 34% to 39% annually for the next 2.5 years?

Well, then, LGGNY and TFC are what you want to buy today.

For further details see:

Prudential Is Great, But Buy These 6.5+% Yielding Blue-Chips Today