2023-09-30 04:56:06 ET
Summary
- Prudential comfortably covers its dividend from both after-tax adjusted operating income per share and free cash flow.
- The company's after-tax adjusted operating income per share surged higher in the second quarter.
- The asset manager and insurer enjoys remarkable credit ratings from the three major credit rating agencies.
- Shares of Prudential are priced 13% below fair value based on my inputs into the discounted cash flows model and dividend discount model.
- Prudential's 5.3% dividend yield and mid single-digit annual after-tax adjusted operating income alone could generate annual total returns of around 10% in the next 5 to 10 years.
After chasing yield and losing my shirt in my younger years a few times, the School of Hard Knocks has taught me one thing: Dividend investing isn't so much about the dividends as it is about sustainability.
When I used to invest in dividend stocks, I thought more about starting dividend income. What I failed to consider is what my future dividend income would be, if anything at all in the case of some stocks I purchased like The GEO Group (GEO) (easily one of my top three worst picks on Seeking Alpha).
This is why I now put more stock into a company's track record as a dividend payer and decisively steer clear of double-digit dividend yields. Well, Prudential Financial (PRU) has been in business for nearly 150 years . The company is about as unyielding as the Rock of Gibraltar, which it uses as its logo to evoke confidence in its customers.
Due to Prudential's unbelievable durability through recessions, depressions, and pandemics, it holds a prominent position in my portfolio : The stock is my 24th biggest holding, accounting for 1.2% of my total dividend income. For the first time since March , let's assess Prudential's dividend, operating fundamentals, risks, and valuation to more thoroughly understand what I like about the stock enough to rate it as a buy.
A High Dividend That You Can Trust
For the sake of clarification, let me start by informing readers what I mean by high-yielding. I consider a dividend yield that is around 100 basis points higher than the risk-free rate or 10-year treasury to be high-yield. Seeing as Prudential's dividend yield is 5.3% and the 10-year treasury yields 4.6% , the stock is right around the cutoff to consider it a high-yielder. For context, Prudential's forward dividend yield is substantially higher than the financial sector median of 4%. That is probably why the company was awarded a B+ grade for the metric by Seeking Alpha's Quant system.
If Prudential's solid starting income wasn't appealing enough, there's more: For its starting yield, the company's 5.9% annual dividend growth rate for the past 10 years isn't too far below the financial sector median of 7.9%.
Better yet, Prudential's dividend is supported by both after-tax adjusted operating income per share and free cash flow. The company recorded $9.46 in after-tax adjusted operating income per share in 2022. Against the $4.80 in dividends per share paid during that time, this equates to a 50.7% dividend payout ratio.
Prudential logged $4.2 billion in free cash flow for 2022. Compared to the $1.8 billion in dividends paid in the year, this works out to a modest 43.6% free cash flow payout ratio (info sourced from page 309 of 373 of Prudential 10-K filing ). Analysts also think that Prudential's earnings will grow by 8.1% annually for the next three- to five years. For these reasons, I am reaffirming my 5% annual dividend growth rate over the long haul.
The Company Is Rebounding
As you'd expect for a company that has been in business for nearly a century and a half, Prudential has achieved significant scale. The company has 50 million customers in over 50 countries for its group life insurance, disability insurance, and fixed and variable annuity products. Prudential was and still is one of the biggest asset managers on the planet, with $1.4 trillion in assets under management as of June 30.
Prudential did well in the second quarter of 2023. The company's after-tax adjusted operating income per share grew by 25.6% over the year-ago period to $2.94 during the period.
These strong results were driven by Prudential's U.S. Businesses and International Businesses segments. The former's adjusted operating income soared by 66.8% year over year to $956 million for the second quarter. This was due to better investment spreads and favorable underwriting results for its insurance policies. The International Businesses segment posted $784 million in adjusted operating income in the quarter, which was up 13.3% over the year-ago period. This was the result of higher investment spreads, as well as business growth.
Prudential's global investment management or PGIM segment reported $179 million in adjusted operating income during the second quarter, which was a 13.1% year-over-year decline. This was due to lower asset management fees stemming from net outflows and higher expenses. Finally, the company's corporate and other segment reported a $527 million adjusted operating loss. This was greater than the $321 million in adjusted operating losses that were recorded in the year-ago period. That's the result of higher expenses and unfavorable foreign currency translation from the stronger U.S. dollar.
Prudential's adjusted book value per share was almost flat at $97.38 in the quarter - - lower by 0.5% over the prior year's second quarter.
The company remains financially sturdy, with $4.5 billion in highly liquid assets. Along with billions of dollars in off-balance sheet credit facilities that it can access, this is why S&P, Moody's, and Fitch respectively have recently assigned A, A3, and A- credit ratings to Prudential (details according to Prudential Q2 2023 earnings press release and Prudential Q2 2023 Investor Update Presentation).
Risks To Consider
Prudential is a well-established business with decent fundamentals. However, there are still risks to consider before buying the stock.
As a financial company, Prudential is vulnerable to economic recessions and poor stock market performance. The probability of a U.S. recession in the next 12 months remains greater than not at 60.8% as of late September 2023. The most likely and best-case scenario is that the recession will be a mild one, which will hardly impact Prudential. But if this consensus among economists is wrong and a deep and prolonged recession materializes, the implications may be felt more greatly by Prudential.
Prudential also faces the risk that goes along with being an insurer. If actual deaths from the likes of pandemics and natural disasters materially differ from predicted deaths, the company may have to pay much more in claims than expected. That could weigh on its financial results.
A Moderately Undervalued Stock
Prudential is a high-quality dividend stock that appears to be attractively valued. My inputs into the following two valuation models support this argument.
The first valuation model that I'll utilize to gauge the fair value of shares of Prudential is the discounted cash flows or DCF model. This consists of three inputs.
The first input into the DCF model is the last 12 months of after-tax adjusted operating income per share. Prudential has put up $10.14 in after-tax adjusted operating income per share in the past four quarters.
The second input for the DCF model is growth forecasts. Aiming to be on the safe side, I am assuming just 2% annual after-tax adjusted operating income per share growth for the next five years. I'll then factor in a deceleration to just 1% annual growth in the years that follow.
The third input into the DCF model is the discount rate, which is the annual total return rate that an investor requires. I will use 10% for this input.
Using these inputs for the DCF model, I get a fair value output of $118.66 a share. This suggests that Prudential's shares are trading 20% below fair value and offer a 25% upside from the current price of $94.92 a share (as of September 29, 2023).
Investopedia
The other valuation model that I will employ to value shares of Prudential is the dividend discount model or DDM. This also has three inputs.
The first input for the DDM is the annualized dividend per share, which is $5 for Prudential.
The next input into the DDM is the cost of capital equity. This is another term for the annual total return rate that an investor demands from their investments. I will again use 10%.
The last input for the DDM is the annual dividend growth rate or DGR. I'll use 5% for this input.
Plugging these inputs into the DDM, I come out to a fair value of $100 a share. That means Prudential's shares are priced at a 5.1% discount to fair value and can provide a 5.4% capital appreciation from the current share price.
Averaging out these two fair values, I compute a fair value of $109.33 a share. This implies that shares of Prudential are trading at a 13.2% discount to fair value and offer a 15.2% upside from the current share price.
Summary: Prudential Is A Great Income Stock
Prudential isn't a stock that is going to make you rich overnight. Since you're reading this article, you're presumably interested in buying and holding reliable income stocks, though. Even after its dividend cut in 2008, the company fully restored its dividend to pre-Great Recession levels in just two years. Having upped its dividend for the last 15 years, Prudential has been one of the more consistent dividend payers in the financial sector.
The company is also fundamentally solid, with after-tax adjusted operating income per share beginning to recover. Not to mention that it has a fortress-like balance sheet to fall back on if a worse-than-expected recession hits soon. Trading more than 10% below my estimated fair value, Prudential's cheap valuation seals the deal to make it a buy for income investors.
For further details see:
Prudential Financial: Buy This High-Yielding Blue Chip Stock For Rock-Solid Dividend Income