2023-07-28 17:07:11 ET
Summary
- Prudential Financial Inc has one of the most favorable dividend yields among its peers, but its profitability has been significantly lower on average.
- The company's high dividend yield is offset by its conservative share repurchases and weak as well as cyclical underlying performance in EPS over the past 10 years.
- This analysis suggests that the diversified financial sector may not be worth buying into in general with Aflac, a sole insurer, standing out as a more fundamentally sound business model.
Introduction
In this article, I analyse Prudential Financial Inc ( PRU ) in relation to five industry peers. Not each peer has the same business model, which makes for a nuanced comparison of profitability metrics as well as shareholder returns. Prudential is an insurer as well as an asset manager. This means that it has a more complex corporate overhead and more diversified business objectives compared to a sole insurer such as Alfac Inc ( AFL ). Prudential currently has the most favourable dividend yield in comparison to its peers, but the company's profitability is substantially lower in comparison. Furthermore while the dividend yield is high, share repurchases are low which means that from a shareholder return perspective there are peers that have given more.
In all, Prudential's business has fundamentally low profitability and volatile earnings which lends the stock a sell rating in comparison to some of its peers.
Company Overview
Prudential has several different branches under its tree. First, it operates PGIM that provides investment management services for a diversified selection of investment products. Second, the company operates a Retirements Strategies segment that provides annuity products for retirees. This segment comprises of standard fixed and variable annuities as well as individual retirement strategies. Third, the company offers group and individual life and disability insurance as well as AssuranceIQ. Finally, the company operates a general International Segment that delivers insurance, asset management, and retirement products.
Since the company is operating in a diverse range I would definitely consider it a diversified financial. The first question I want to answer in this article is: how does Prudential fair against other diversified financials? Second: Is there any merit to diversifying into asset management and retirement instead of focusing solely on insurance?
An Analysis of 5 Peers
Prudential Financial Inc ( PRU ), Aflac Inc ( AFL ), MetLife Inc ( MET ), Sun Life Financial Inc ( SLF ), and Manulife Financial Corp ( MFC ) are five diversified financials all trading between $30-$48 billion. Prudential, Sun Life, MetLife, and Manulife operate two business segments: insurance and asset management; Aflac underwrites insurance premiums only. The reason I have included Alfac is to compare the effect of operating a solely insurance business versus an insurance business, plus asset manager.
A Profitability Comparison
The sole insurer AFL is currently outperforming its peers from a profitability standpoint. Its return on equity and invested capital are substantially higher now, but this hasn't historically always been the case. The asset management businesses experienced a nice upswing during 2021 due to large investor inflows.
Prudential, for example, recorded $4.9 billion in asset management fee revenue in 2021 compared to $4 billion in 2022. This was one significant factor that contributed to the company's net loss in 2022. Another contributing factor to the net loss was benefits paid, which increased 13% YoY, while premiums only grew by 9.2% over the same period ( Prudential 10K, 2022 ). The largest factor, however, has been realized investment losses of ~$3.3 billion, which weighed down the income statement substantially.
When we compare these results with the sole insurer, Aflac, we see a company that actually scaled down its underwriting activity as premiums declined by 14%. But, policy benefits paid also decreased by almost exact same amount of 13.3%. This dynamic allowed the company to remain very profitable, with $4.2 billion in net earnings - lending the company a P/E ratio of around 10 (based on the prior year) and a net earnings margin of 21.5% ( Aflac 10K, 2022 ).
While speaking of earnings ratios, we can look into a comparison of these companies' price/earnings ratios. Below, we can see that Prudential actually has the lowest Non-GAAP (FY1) and GAAP (FWD) "P/E" ratio out of all its peers. However, given that its forward P/E ratio is just slightly lower than its FY1 ratio, this means that the company is not expecting to significantly increase earnings going forward. As a matter of fact, the picture is even bleaker for Manulife, SunLife, and Metlife which all have higher FWD "P/E" ratios than FY1 "P/E" ratios. The only firm, again, that seems to be continuing its strong performance is Aflac. Aflac has a Non-GAAP (FY1) "P/E" ratio of 12.49 as compared to its forward "P/E" ratio of 11.78.
Dividend Yield Comparison
From a dividend yield perspective, Prudential stands out. Currently, the company can be bought at a solid 5.04% yield which is supported by solid fundamentals in the previous quarter's earnings ( Prudential Q1 Earnings Release ). Notably, the company returned to net income profitability due to realized investment gains and strong performance in its fundamental business. Manulife is the only peer that is offering a better dividend yield now at 5.22%, whereas the others are relatively unimpressive from a dividend perspective.
We can especially see that Aflac is at the bottom of dividend yields compared to peers, as a stark comparison to its lead in profitability. One reason for this is that the company instead conducts a relatively large amount of share repurchases in order to reward shareholders. This also holds especially true for MetLife which has conducted the highest amount of share repurchases over the past three years and also has a reasonable dividend yield of 2.43%.
Furthermore, Prudential's exceptionally high dividend yield could also partly be explained by its share repurchase activity. During 2022, the company had one of the lowest repurchase volumes compared with its peers (Except for Sun Life which conducts no share repurchases).
These two capital allocation strategies need to be considered a trade-off for investors. We cannot just look at one or the other, but rather the two together as a whole. Therefore, below is a table of the total capital returned to shareholders during 2022 for these five peers. These can be found in each of the company's consolidated financial reports for 2022.
Peers | Aflac | Prudential | MetLife | Sun Life | Manulife |
Shareholder Return () | 3380 | 3305 | 4924 | 1617 | 4671 |
Out of the five companies, Metlife returned the most to shareholders in 2022. This is reflected in its market cap prior to the company taking a steep dive from a peak of $60 billion in April and May of this year. The reason for the decline was a poor first quarter, in which the company missed Wall Street's estimates ( Seeking Alpha News ). After Metlife is Manulife, Aflac, Prudential, and finally Sun Life. From this perspective, Prudential's high dividend yield does not make up for its conservative share repurchases. Even Aflac, with the lowest dividend yield, returned more capital to shareholders last year.
Historical Shareholder Return
Now if we include capital gains as a factor of shareholder return, we can get an even better picture of the historical performance of the five peers. This is an image showing the total return of $10,000 invested ten years ago. Stock returns as well as dividends are included. As we can see Aflac and Sun Life stand out as the best performers. The rest of these companies hardly doubled the initial investment.
Interestingly, Prudential stock has only appreciated by around 17% over the last ten years while the rest of the return is made up of dividend payments. Over time stock performance can be explained by, to an extent, its EPS growth. For example, Aflac has doubled its EPS over the past ten years, which is one explanation to it being a winner with regard to total returns. Furthermore, Manulife and Sun Life have even outperformed Aflac in EPS growth, which can be attributed to strong underlying growth in their businesses. We can see that the two companies that stick out are MetLife and Prudential. Prudential's EPS has declined by 90% over the past 10 year period, due the unique comparison of last year's negative results. MetLife has performed slightly better with a small increase in EPS of 34% over the past 10 years.
The denominator in common between these two companies is cyclicality. In the graph below we can clearly see the drastic swings in earnings - especially for Prudential. So, even though Prudential had the highest net income out of its peers in 2018, Sun Life, Aflac, and Manulife have steadily increased earnings over time.
The Investment Case
Even though Prudential is currently selling at a 5% dividend yield, the company has proven to provide the worst total return over the past ten years in comparison to its peers. This is due to a number of factors, including the fact that Prudential has had very cyclical underlying EPS performance and is currently in a downswing with negative profitability. Although this has historically not always been the case, the fluctuations in the internal performance of this company are alarming for a sector in which investors expect stable returns. Furthermore, the company's high dividend yield is somewhat offset by the company's weak share repurchase programs and below average retruns on invested capital. So to answer the first question, Prudential has not fared very well in comparison to its diversified financial peers. However, these direct peers have not delivered very impressive share performance over the past 10 years compared to the sole insurer.
In this case, Aflac stands out as driving a more fundamentally sound business model which is reflected by high return on equity and invested capital. Furthermore, the company rewards shareholders well with modest dividends and substantial share repurchases. So to answer the second question, this analysis suggests that the diversified financial sector may not be worth buying into at all. If history gives some hint for the future, then it would suggest selling Prudential and buying Alflac.
For further details see:
Prudential: Dividend Not Driving Shareholder Value Compared To Peers, Aflac