2023-12-05 13:05:33 ET
Summary
- Prudential Financial is downgraded from Strong Buy in June to Buy, in line with consensus from SA analysts and quant system.
- Positive drivers are a +5% dividend yield and dividend growth, low exposure to commercial office loans (2%), and benefitting from rising equity values in its asset portfolio.
- Negative headwinds to consider are declines in revenue and earnings, a share price well above its summer lows, and price-to-earnings overvaluation.
Company Snapshot
Brisk December mornings like this often remind me of taking the train in my home state of New Jersey and seeing the logo of Prudential Financial ( PRU ) rise above the Newark skyline, just 20 minutes or so from Manhattan, so for this week's research note I am revisiting this stock I rated back in June.
Since my strong buy rating in early June , the share price has risen an amazing 14.4%, evidence that the market shared my bullish sentiment on this stock and recognized its value:
In today's rating, I'll be applying my updated methodology and using some data from its most recent quarterly earnings release in November.
A few relevant facts about this company are that it has roots back to the 1870s, has 50MM customers, trades on the NYSE, and has a diversified mix of individual and group insurance as well as retirement solutions. A fun fact also is that the company has its own family of mutual funds as well, through its PGIM business.
Total Rating Score
Based on the score total in my scoring matrix above, I'm rating this stock a buy this time around.
Compared to my last rating of strong buy, this is a slight downgrade.
Comparing my rating to the consensus on Seeking Alpha today, my rating is aligned with the consensus from both SA analysts and the SA quant system:
Rating Methodology
My simplified and straightforward 8-point approach focuses on a few core areas such as revenue and earnings growth, dividend income opportunity, undervaluation opportunity, a share price presenting a value-buying potential, and identifying a key risk of the company as well as its potential impact to an investor.
Top-Line Revenue YoY Growth
I am looking for any positive revenue growth on a YoY basis, and here is what I found from income statement data:
In the quarter ending September they achieved $8.35B in total revenues, vs $20.2B in September 2022, a 59% YoY decline.
However, that is behind us and what is my outlook going forward for this firm? A business segment I can see having growth potential is their asset management shop, since it makes money on fees based on the asset value managed, and I think the underlying market values could go up in 2024.
Consider that according to their Q3 earnings release :
PGIM assets under management of $1.219 trillion were up 1% from the year-ago quarter, primarily resulting from equity market appreciation.
Supporting my thesis also is that the momentum of the S&P500 index has had a 1 year price return of nearly 13%.
Net Income YoY Growth
I am looking for any positive net income growth on a YoY basis, and here is what I found:
When comparing the quarter-ending in September of a $802MM net loss with that of September 2022 which saw a $92MM net loss, that is an over 7x decline on YoY basis. It is also a decline vs December 2022 and March as well which had seen a positive net income of $1.4B, so it is not a one-time event.
After doing some digging, according to the Q3 results the following impacted earnings:
Net Loss in the current quarter included $2.491 billion of pre-tax net realized investment losses and related charges and adjustments, largely reflecting the impacts of rising interest rates.
This also correlates with income statement data from Seeking Alpha, showing around $2.8B in net losses on sales of investments held.
Going forward, I expect this to stabilize as interest rates stabilize or start dropping in 2024, pushing underlying bond values up and the values of the portfolios holding those bonds. If you look at that same income statement for Prudential in the period from March 2021 through December 2021 they were selling investments at a net gain not a loss.
My go-to tool for following the rates discussion is CME FedWatch , which currently predicts a 98% chance that rates stay the same after the Fed's December policy meeting. Interestingly, it is already predicting a 32% chance that rates drop after the March 2024 meeting.
Dividend 10-Year Growth
I am looking for dividend 10 year growth trends, and here is what I found:
Now this is the type of chart I like to see: a steady upward trend of 10 year dividend growth, as a sign this firm continues to grow its ability to return capital back to shareholders.
For example, its annual dividend in 2013 was $1.73 vs $4.80 in 2022, an over 200% growth in 10 years.
So, I think this deserves another point in the buy category.
Dividend Yield Above Average
I am looking for a dividend yield above its sector average, and here is what I found, using dividend data :
In this study, I compared Prudential's trailing dividend yield of 5.12% (which is also their forward yield currently as well) with the yield of three large peers in the US and Canada insurance space: MetLife ( MET ), Travelers Companies ( TRV ), and Sun Life Financial ( SLF ).
In this peer group, Prudential is at the top of the pack, with Canada's Sun Life coming in right behind at 4.33%.
These metrics are relevant particularly to dividend-income investors like myself, and many of my readers though not all, because in comparing different peers as a potential buyer I am trying to get the best yield for my capital invested, assuming I will hold on to the shares longer-term and earn the quarterly dividend cashflow.
In this section, I'll be adding a point to the buy category as this yield presents a buy opportunity.
Share Price vs 200-day Average
My portfolio strategy prefers dip-buying opportunities when the share price falls below the 200-day simple moving average , so here is what I found:
In the pre-market on Monday December 4th, the share price was hovering at $97.74, which is now 8.5% above the 200-day simple moving average that I am tracking. If you compare to my June buy rating, that share price was far below the same moving average, so I think that would have been a great dip-buying opportunity if you look at the chart.
The current price I would consider more of a hold or sell, in my opinion, so I am adding a point in the hold category of my score matrix since I am on the fence about this price.
P/E Valuation vs Average
I am looking for an undervaluation opportunity when it comes to price-to-earnings , and here is what I found:
From valuation data , I can see that the forward P/E ratio is now at 16.02, about 59% above the sector average.
Considering the average is closer to 10x earnings, and this stock is at 16x, I think what is driving this higher multiple is a combination of the share price jumping well above the moving average while at the same time the earnings posted a significant decline.
So, I will agree with Seeking Alpha's "D" grade of this valuation as I consider it overvalued. I don't think it is justified at 16x earnings when earnings have declined during multiple quarters and not just one, so I am adding a point to the "sell" column in my score matrix.
P/B Valuation vs Average
I am looking for an undervaluation opportunity when it comes to price-to-book value , and here is what I found:
As of this article, the forward P/B ratio is 1.36, about 24% above the sector average.
Tying this multiple to the financials on the balance sheet , consider that equity (book value) has risen to $26.9B vs $17.1B in September 2022, a 57% YoY increase in equity.
So, although the share price has risen lately, so has book value and has done so by a lot, therefore I think a price multiple of 1.3x book value is justified for this stock so at this valuation I would add a point to the buy category in my score matrix.
Key Risks
As an investor and analyst I find it relevant to analyze risk as well, and here is one key risk of this company I identified:
Risk in this type of business usually stems from things like exposure to certain types of assets in the company's investment portfolio, and or the risk of an uptick in policy claims resulting in massive claim payouts impacting company cash.
The good news is that policy benefit payouts actually declined on a YoY basis, going from $16.8B in September 2022 to $5.98B in September 2023, a 64% decline.
Next, in looking at this firm's exposure to commercial real estate loans, particularly office properties, more good news is that their office exposure is just 2% of the portfolio, with a much larger exposure to residential multi-family property:
The reason I am highlighting the office segment is because of the surge in media stories this year surrounding office property defaults. For instance, a November 29th Bloomberg article headline read "overdue office loans are a new pain point for banks in FDIC Report."
Also, an early November article in The Financial Times highlighted the impact to the financial sector in the US:
Among regional banks, Pittsburgh-based PNC had one of the biggest spikes in delinquent commercial real estate loans, more than doubling in the quarter to $723mn. “The pressures we anticipated within the commercial real estate office sector have begun to materialise,” Rob Reilly, PNC’s chief financial officer, told analysts last month.
With that said, considering that Prudential has a 2% exposure to office property would add to my confidence sentiment, not to mention that according to its Q3 results the firm has $4.3B of highly liquid assets and a double-A rating level as of September.
I think now that interest rates appear to be stabilizing and no further hikes are on the table, it could pave the way for rate decreases in 2024 which would make the cost of debt cheaper for borrowers and perhaps ease some of those default concerns.
When it comes to risk profile, I am therefore giving a point to the buy side for this stock.
Wrap-Up
To summarize today's note and re-rating, I am slighting downgrading this stock to buy from my previous strong buy.
Driving this are positives like 5% dividend yield and growth, low risk profile and low price-to-book valuation.
Offsetting factors are declines in revenue and earnings, price-to-earnings overvaluation, and a share price trading now well above its spring and summer lows.
I would still consider adding it to an existing portfolio of financials/insurance stocks that pay 5% or more in dividend yield, so I'm also adding it to my "dividend quick picks" of the week.
I believe it remains poised to capitalize on future interest-rate cuts, rising equity values, and its position as a systemically very large player in its space with a well-established brand.
For further details see:
Prudential Financial: Downgrade To Buy As 5% Dividend Yield Remains Attractive