PUKPF - Prudential: Very Reasonably Priced Play On Asian Growth

2023-12-08 14:19:56 ET

Summary

• Prudential stock has been punished all year for its greater China exposure.
• The ex-China business is, however, still growing strongly, while Hong Kong has continued to defy expectations.
• At the current low-teens earnings multiple, I think Prudential should quite easily grow into its valuation over time.

Today's version of insurer Prudential plc ( PUK ) is all about Asia (>90% of income) and, to a lesser extent, Africa following a series of spinoffs that effectively de-merged its UK (M&G plc (MGPUF)) and US (Jackson Financial (JXN)) operations. This makes Prudential an interesting play on growth in China and emerging Asia - regions with tremendous growth as their populations mature and move up the income ladder over time. Backed by a best-in-class distribution network throughout Asia and a multi-channel strategy that has seen it penetrate everything from bank branches to digital apps (via health and wellness app, Pulse), Prudential has an uncharacteristically attractive growth runway compared to most other UK/US-listed insurers.

Since I last covered the stock, Prudential has benefited from a strong post-reopening surge in earnings, but pessimism on the China outlook has hit valuations hard. Yet, a solid Q3 trading update did more to reinforce the positives than the negatives, in my view, with management calling for more strength into Q4 2023 as well. Admittedly, the company still overindexes to a challenged Chinese market (onshore and offshore via Hong Kong), but these near-term economic headwinds pale in comparison to the long-term opportunities offered by Prudential's diversified portfolio. With the insurer's model also underpinned by a stable recurring base of premiums and a rock-solid balance sheet, Prudential should have no issues weathering a downcycle in China. At a relatively discounted low-teens P/E multiple (vs. high-teens % bottom-line growth), shares are very reasonably priced and pay a decent ~2% dividend yield to boot.

Q3 Update Unveils More Top-Line Growth

Prudential doesn't typically post detailed updates outside of its half-yearly reporting, but its Q3 update nonetheless offered positive insight into its underlying momentum. Headlining the result was a significant YoY increase in post-tax new business profit on business sold. New business profit would have been even higher YoY after normalizing for interest rates. Similarly, an implied >30% growth in Q3 (+40% YTD) annual premium equivalent sales (i.e., one-tenth of new business premiums plus annualized yearly premiums across all insurance products) confirmed the positive underlying momentum.

Elsewhere, Prudential did see minor P&L volatility from market and foreign exchange fluctuations, as well as one-off redemptions from former UK asset management subsidiary M&G. While overall funds under management (now mainly via Asian asset manager Eastspring) are slightly down as a result, the company's intact asset mix and diversified presence across clients and asset classes mean things are business as usual on the ex-insurance side.

The quarterly insurance strength echoed Asia's other leading insurer, AIA Group's ( AAGIY ) results, which featured a similarly strong pace of new business growth. For both insurers, growth was captured across their multi-market, multi-channel presence. By geography, the key YoY growth contributor remains Hong Kong, as offshore new business continued to grow strongly post-China reopening ( "increased sales to both Chinese Mainland visitors and Domestic customers compared with the same period last year" ). Domestic Hong Kong growth, on the other hand, saw a modest deceleration. Still, the country's Q3 new business sales came in 30% above pre-COVID peak levels - despite visitor numbers not yet fully regaining prior highs.

The company also noted that "fifteen of our life markets across Asia and Africa delivering double-digit growth in new business profit," with India, in particular, emerging as a new growth engine. Given the overall Q3 growth also came despite mainland China suffering from regulatory-driven distribution headwinds, Prudential deserves a lot of credit for its continued success in tapping emerging Asian growth.

Near-Term Outlook Less Certain but Structural Drivers Intact

Given the subpar macro and financial performance of Chinese and Hong Kong markets, it was perhaps no surprise that management sees that "the environment continues to be challenging" heading into Q4. There's a good chance Prudential's overall bottom-line outperforms these markets, though, given management commentary that "new business momentum has continued into the fourth quarter supported by our multi-market growth engine."

And even in the likely event that China offshore/Hong Kong decelerates from a low double-digit growth pace, Prudential's base of recurring insurance premiums should shield it from the worst of the impact. Elsewhere, Southeast Asia and India will remain growth engines, though not enough to offset a mainland China slowdown. The silver lining is that Prudential's challenges in China are likely well-understood by the market after a string of subpar earnings performances this year. With the bar lowered, any success in diversifying its mainland product mix and/or adapting its distribution network to regulatory changes could see China turn out better than expected.

More broadly, it's worth taking a step back and keeping an eye on the longer term. Yes, China will remain a headwind over the next year or so, but the insurer's leverage to broader emerging Asia, where mid-single-digit % GDP growth and fast-expanding middle classes are the norms, should see earnings move much higher over time. Plus, Prudential boasts a strong multi-decade track record in Asia and a multi-channel distribution that will be immensely difficult for competitors to replicate.

Better visibility into underlying profitability and cash generation at the full-year announcement in February/March next year (vs a top-line focused Q3 trading update) could catalyze some upside to currently undemanding valuations. While waiting, investors get paid a well-covered and steadily growing ~2% dividend yield.

Very Reasonably Priced Play on Asian Growth

Investors willing to underwrite Asian growth will find a lot to like in Prudential plc. The insurer not only maintains leading market shares in its key Asian markets but also has a best-in-class distribution network that should keep it on top for a long time. In turn, investors in Prudential get to profit from all the tailwinds associated with a rising (and maturing) Asian middle class over the long run.

The catch here is that Asia is going through a bad patch economically, particularly the Greater China region. While Prudential's earnings growth numbers have been strong YoY and will most likely remain that way into Q4, next year will be a different story as China's post-reopening boost fades and the insurer contends with a higher base. Against the near-term weakness, however, the company's diversified portfolio, recurring premiums, and balance sheet shield investors from some of the downside. And having de-rated this year to a low-teens 2024 earnings multiple (vs. mid to high-teens % profit growth potential through 2027), investors don't need too much to go right for the stock to work in my opinion.

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