2023-06-16 09:22:04 ET
Summary
- Jackson Financial, a spin-off from Prudential, offers potential growth opportunities due to its attractive valuation and commitment to dividends and buybacks.
- The company faces risks such as higher interest rates affecting annuity sales and a short track record since its spin-off in 2021.
- Despite these risks, I believe Jackson Financial is a buy, as the current valuation provides a margin of safety even if execution is disappointing.
Introduction
As an investor focusing on dividend growth stocks, I seek new investment opportunities in income-producing assets. I most often add to existing positions when I find them attractive. I also take advantage of market volatility to start new positions in companies trading for a high valuation. It helps me to diversify my holdings and increase my dividend income for less capital.
The financial sector is attractive, particularly Jackson Financial ( JXN ). We see that the financial sector is lagging behind the broader market. Several regional banks declaring bankruptcy have lowered the system's trust level. However, while the entire banking system suffers from lower valuations, finding high-quality companies that can deal with the harsher business environment is challenging. In this article, I will analyze Jackson Financial and examine whether it is a good dividend growth opportunity.
I will analyze Jackson Financial using my methodology for analyzing dividend growth stocks. I am using the same method to make it easier to compare researched companies. I will examine the company's fundamentals, valuation, growth opportunities, and risks. I will then try to determine if it's a good investment.
Seeking Alpha's company overview shows that:
Jackson Financial primarily provides a suite of annuities to retail investors in the United States. The company operates through three segments: Retail Annuities, Institutional Products, and Closed Life and Annuity Blocks. The Retail Annuities segment offers various retirement income and savings products. The Institutional Products segment provides traditional guaranteed investment contracts, funding agreements comprising agreements issued in conjunction with its participation in the U.S. federal home loan bank program, and medium-term funding agreement-backed notes. The Closed Life and Annuity Blocks segment offers various protection products, such as whole life, universal life, variable universal life, and term life insurance products.
Fundamentals
Revenues of Jackson Financial have increased by 175% in the last two and a half years since the spin-off from Prudential ( PRU ). The increase in sales results from additional clients and slowly increasing prices, mainly for annuities. In the last quarter, the company has achieved a total retail annuity sales of $3.1 billion. In the future, as seen on Seeking Alpha, the analyst consensus expects Jackson Financial to keep growing sales at an annual rate of ~2.5% in the medium term. The market anticipates rates to be lower in the long term, with the 10-year bonds yielding 3.74%. Lower rates will mean more demand for annuities that promise a steady income.
The EPS (earnings per share) has grown by 7% in the two and a half years since the spin-off. Higher rates have hurt the company, as some of its assets as an insurer have lost some value. Therefore, the expectation is for Non-GAAP earnings to be 12% lower this year despite a significant buyback plan. In the future, as seen on Seeking Alpha, the analyst consensus expects Jackson Financial to keep growing EPS at an annual rate of ~6% in the medium term. As rates will be lower in the long term according to the current market anticipation, there will be lower costs for Jackson Financial as it will have to promise a lower rate of return to sell its annuities.
The dividend has a short track record, since the company has only been trading since September 2021. However, the current yield is already extremely attractive as it approaches 8%. The payout ratio is low at 8.5% when using GAAP earnings and ~16% when using non-GAAP earnings. The company has already raised the dividend twice and keeps stating that it is committed to paying dividends. I expect the company to keep growing the dividend faster, which should be higher than the 6% EPS growth rate. I think the company will want to expand its payout ratio to attract more investors, as it keeps mentioning that the dividend is a priority.
In addition to dividends, companies tend to return capital to shareholders via buybacks. Jackson Financial is doing the same, as it has bought shares worth $70M in the last quarter alone. Buybacks support EPS growth as they lower the number of shares. Since the spin-off, the number of shares has declined by almost 13%. When the share price is low, buybacks are highly effective, which is the current case for Jackson Financial. In the future, I believe buybacks will be a priority, and more capital will be invested in them than dividends. It is the result of the low valuation that makes every dollar extremely effective.
Valuation
The company's P/E (price to earnings) stands at 2 when using the EPS estimates for 2023. Paying two times the forward earnings of a company seems extremely attractive. The company is a new company with a short track record of earnings and independence, creating higher uncertainty. Comparing the company's valuation to other players in the field of annuities shows that Jackson Financial is extremely undervalued. Its peers are not trading for a high valuation compared to the market, but they are still trading for a valuation which is at least three times higher than Jackson Financial.
The graph below from Fast Graphs shows that the company has been trading for an attractive valuation since the spin-off two and a half years ago. The average P/E ratio during that time was 1.9, which aligns with the current P/E ratio of 2. The company has seen its EPS decline due to the higher rates. Still, from 2024, the expectations are for it to return to an increasing EPS trajectory as interest rates are expected to stabilize and even decrease. As the company performs according to the estimates and builds a track record of stable and growing EPS, I believe we will see its valuation ticking up towards the higher valuation of its peers.
Opportunities
Spin-off companies tend to outperform the broader market following the spin-off. They are usually smaller than the parent companies and are often sold by investors who invested in the parent company, as the spin-off is a side business. For example, investors invested mainly in Prudential for its diversified portfolio of insurance products and not in the annuity business.
In addition, they also lack analyst coverage compared to the parent companies. Prudential has 15 analysts covering it, according to Seeking Alpha, while Jackson Financial has only 4. Moreover, the new entity lacks investor confidence due to its short track record. We can track the company for less than three years and see Prudential's performance for decades. In my opinion, as investors gain confidence that the company can execute well, it will slowly close the valuation gap. Many researchers have shown how spin-off companies tend to outperform the market.
A comprehensive study conducted at Purdue University revealed that spinoff shares achieved an excess return of more than 10% per year above the US stock market return over 36 years – between 1965 and 2000. Researchers recently extended the study up to 2013, and the results were the same.
( https://longrunplan.com/spin-off-shares-achieve-better-return-indices/ )
In my opinion, the current valuation offers a significant upside for the company, as its peer group is trading for a much higher valuation. In addition, I also believe that it offers an extremely high margin of safety for investors since if the company fails to meet its expectations and grows in the medium term as interest rates stabilize, a strong cash flow is still translated into dividends. That alone is worth a higher valuation, I believe.
Jackson Financial has performed well over the last two years. It kept selling annuities despite the harsher business environment. It also managed to maintain an ample amount of liquidity to make sure that there was no risk to its solvency. At the end of the quarter, the company's cash and highly liquid securities were worth more than $1.5 billion. Therefore, I believe the company can keep investing new cash conservatively, pay dividends and buy back stock.
Risks
Higher rates are the most significant risk for Jackson's Financial annuities business. Higher rates make it easier for investors to gain risk-free interest, thus lowering the demand, and we can see lower quarterly sales. Therefore, Jackson Financial has to offer higher rates to its clients, increasing the company's expenses and thus pressuring earnings. The combination of lower demand for annuities and the need to provide higher rates makes it harder for companies to grow efficiently.
Q1 Financial Results
In addition, investors in spin-off companies take the risk of a short track record. Jackson Financial offers a short track record when it comes to execution. It has never been an independent company, so it is hard to see a trend in its execution. This is also a risk when looking at dividend growth. The company has only two years of dividend growth history, and while it is committed to the dividend, it lacks the record to prove it.
The fact that achieving growth is harder and the need to reward investors more generously opens the door to execution risk. The company saw lower EPS in 2022, and it is also the forecast for 2023. The current forecast is for 2024 to be a positive year with a 13% EPS growth, according to Seeking Alpha. However, growth is harder to achieve now, and if interest rates stay that high, the growth pace may be lower, and Jackson may even see its EPS keeps declining, depending on the market conditions.
As the company's EPS declines, the higher rates are also pressing down on the valuation of the company's assets, mainly bonds. It lowers the value of the company's asset base and book value, and bears are afraid that the company won't be liquid enough to pay its commitment, as the assets are worth much less compared to two years ago. The company deals with this risk by having plenty of cash and short-term securities, but a much longer period of higher rates may make it more challenging.
Conclusion
Jackson Financial is a newborn company following its spin-off from Prudential in 2021. However, since then, it has grown in its top and bottom lines and increased its dividend and buybacks. The company has several growth opportunities both organically as it sells more, but mainly due to its valuation, which creates a vast opportunity for valuation expansion in the medium term.
While there is a significant opportunity in terms of valuation, there are risks to the investment thesis. Higher rates may limit growth in the short term, and there is not enough track record to examine the company's long-term earnings. Still, I believe that the company is a BUY, as the current valuation offers an opportunity and gives enough margin of safety even if the execution is disappointing.
For further details see:
Buy Jackson Financial While The Valuation Is Low