Prudential Financial (PRU) is a company I’ve written about many times over the past year, without providing a company-specific article to base things on. That changes today. Prudential Financial is one of the investments I view with an extremely favorable eye whenever I look to increasing my exposure to qualitative financials.

In this article, I’ll show you why I see the company as one of quality that you can really count on in the long term.

Let’s get going.

Prudential Financial.svg

Prudential Financial – What does the company do?

Prudential Financial is the largest insurance business in the US, with assets exceeding $1.5T. The company provides life insurance, annuities, mutual funds, pension/retirement services, administration, and asset management as well as securities brokerage.

The company provides these products not only to individuals and institutions in the US, but Asia, Europe, and Latin America as well. PRU has hundreds of subsidiaries and holds life insurances valued above $4T.

The company has a very long history – 145 years at this point and was founded in Newark by a man later becoming a U.S. senator. The company was in family hands until 1922. It started trading on the NYSE in 2001. Unlike many of its peers, the company isn’t a US-centric business. It’s international, with earnings flowing from a variety of geographical sources.

(Source: Prudential Shareholder Presentation)

The company currently has 50,000 employees, and annual revenues of around $56B.

The company’s operations are divided into these three segments above. PGIM is the company’s global investment management business. In the US business, we find US insurance solutions, both individual and workplace policies, and a similar structure is found in the International business segment. Aside from this, there is also the Closed Block division. These divisions are then further separated into retirement businesses, group insurance businesses, annuities, and so forth, with the closed block division, accounted for as a business that is reported separately.

(Source: Prudential Shareholder Presentation)

Some of the company’s highlights include a best-in-class Japanese franchise that continually takes market shares from competitors and takes advantage of the nation’s rather unique demographics for products. Japan is a key market for the company, due to its wealthy households, holding a large number of investable assets for company management. Emerging markets are important as future growth platforms, with Latin America, China, and Africa in focus. These markets have very low insurance penetration, offering significant opportunities for a company like Prudential.

The company’s products and services are offered through eight businesses and are distributed through institutional sales teams, retail including third-party networks and distributors, sales teams/nationwide sales organizations, independent brokers, banks/wirehouses, agencies, independent financial planners, financial professionals, independent marketing organization as well as direct-to-consumer platforms.

(Source: Prudential Shareholder Presentation)

Prudential’s revenues, like most insurance businesses with a similar structure to Prudential, come from premiums, service charges, policy charges, commissions, fees, investment returns, and mortgage origination and servicing. What this means is that the company’s income, again like most businesses in the same sector, is highly impacted by macro movements in interest rates and markets, and their ability to perform returns above the benchmarks. What’s also relevant is the company’s ability to retain existing clients, both institutional and otherwise. In addition, the insurance business is highly dependent on correct product pricing, underwriting practices and rating systems, risk evaluation, and related risks.

In short, a wide array of factors impact Prudential’s performance. The company can be said to have control over some of these factors, such as company-specific performance with regard to the overall market and peers, but it does not control what happens on a macro scale, and can only adapt to changing interest rates – much like we’re seeing today.

In many of my articles on insurance providers and financial firms, we’ve been through the impact of low interest rates on a financial. Prudential is no less impacted than are other similar companies, and this is something we’ll look at when we go over recent results.

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It’s impossible to give a detailed overview of this massive a company when we consider the general article-length here. But we can try to look at the macro level. The company’s current portfolio is highly diversified, and an important component of the company’s historical overall outperformance of the general market.

(Source: Prudential Shareholder Presentation)

What appealed to me, in the beginning, was Prudential’s rock-solid company history and performance. Over time, the company has managed to provide essentially double-digit returns with extremely high dividends, while at the same time maintaining a pre-COVID-19 sub-40% EPS payout ratio.

(Source: Prudential Shareholder Presentation)

In short, it would likely take troubles encompassing several years to bring this company into some sort of serious trouble – and COVID-19 hasn’t been “it”. The company hasn’t been around for 2-3 financial crises, it has been around for every major financial crisis the modern world has ever experienced. While it’s important not to put too high an importance on historical numbers, and focus on how the company is actually performing and is set to perform, there is some confidence to be found in these numbers.

The company’s fundamentals are absolutely rock-solid. Few insurance businesses offer “AA” credit ratings, and fewer still have the liquidity and resources that Prudential holds. The company has liquid assets of 3 times its annual fixed charges. A credit facility of $4B, contingent capital of $1.5B, and a Japanese facility of 100B Yen mean that the company has ample flexibility to handle what comes.

In short, Prudential combines the appeal of extremely mature market segments, such as the US, Japan, and parts of the EU with a strong performance, with the appeal of emerging markets and a company positioned to potentially capture market shares in a growing and expanding middle class and mass affluent markets in new regions.

The company earns its money through a variety of fees, commissions, and premiums – and given its history, it’s one of the best companies at doing what it does.

Let’s take a look at how this “rock” has weathered the oncoming tide of COVID-19 and what makes this such a great investment, as I see it.

Prudential Financial – How has the company been doing?

Beginning during COVID-19, the company targeted a number of improvements and cost savings to make the impact of things easier.

(Source: Prudential Shareholder Presentation)

As of 2Q20, these initiatives are still very much on track. The company’s positive fundamentals remain unchanged, with liquid assets exceeding $4.5B. The company has sold its Korea operations, with proceeds coming in during 2H20. Nonetheless and despite these fundamentals, quarterly results were, of course, barring PGIM results, unfavorable YoY.

(Source: 2Q20 Presentation)

No one should expect different given the market dynamics created by COVID-19. The combination of low interest rates – likely to stay low for some time with a very dovish Fed – and these dynamics, and the ongoing outflow from asset management to more passive forms from investing has created an environment where the company needs to adapt quickly and constantly. In the insurance, asset management, and financial business, it certainly separates the wheat from the chaff.

That being said, the company’s fundamentals are still intact – and even with unfavorable results seen above, the company is still very much profitable, only dented on an annual basis. PGIM was, as we can see, actually up, and the company’s income from its various business arms is still diversified from fees, underwriting, and spread.

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Overall, COVID-19 has not caused the company to fall in earnings or expectations to any major degree. The company expects the following.

(Source: 2Q20 Presentation)

The important message from PRU during 2Q20 and 1H20 is that the company is on track, profitable, and is doing quite well despite everything. The company’s well-diversified operations continue to provide sales which in some cases even outperform pre-COVID-19 levels. Far from being in any sort of fundamental danger, the company has adapted to the dynamics and is set to at the very least perform acceptably during this year.

This brings us to company valuation.

Prudential Financial – What is the valuation?

Prudential, despite performing admirably, is trading at discount-level valuations. When taking a look at the company’s current multiples, we find that PRU trades at around 6.34X P/E despite its relatively modest dip in 2020 and expectations for a reversal in 2021-2022.

While there is some ambiguity to these forecasts with a 9% miss ratio on a 2-year basis with a 10% margin of error, it doesn’t change the company’s overall financials, extremely low debt/cap, and well-managed payout ratios, despite nearly giving a 7% yield here.

Even considering very conservative upsides and below 10X-P/E-ratios, we’re looking at potential annual returns of 20% per year until 2022. Given the overall, overvalued state of the market we’re currently in (despite the recent instability and dip), opportunities that combine AA-credit with an excellent upside should be treasured and highlighted. It’s my view that PRU is one such opportunity, amidst similar high-quality insurance businesses. The COVID-19 crisis has brought the company from single-digit conservative upsides to where we now stand at beyond-good double-digit potential upsides at even a conservative forward multiple.

Despite the company’s overall quality, the valuation for Prudential shows a somewhat volatile trend from a historical perspective. For years, the company traded no higher than a P/E-ratio of 8-9.5. As such, I view it as unrealistic to forecast anything higher – because, despite impressive overall 11.58% EPS growth over the past 20 years per year, the company doesn’t merit a higher valuation according to the market.

The company’s earnings growth is expected to flatten somewhat, in part from the poor 2020 results, but also due to the ongoing trends in the business. The company hopes to outweigh this through its growth areas of course, but the future will prove how successful these ambitions are.

It’s my stance that because of the somewhat uncertain prospects here, we should never pay more than 9X forecasted or average earnings for the company. If we average the next 3-year earnings, including the very negative FY20 results to make things more conservative, we get an average 3-year EPS of $11.31, which is actually somewhat lower than FY19 results. Still, based on these expectations and an 8-9X earnings multiple, we get a range of a share price of $90.48 to $101 and an undervaluation range of 40% to 60% based on today’s share price and these multiples.

Even if things turn out worse than these expectations, we can still garner positive returns from a 6-7X earnings multiple, especially based on these improved earnings expectations. Analyst forecasts outside of FactSet agree with this thesis as well, seeing the company worth up to $99/share, with a 13 analyst mean target of $72.15/share at current pricing, which indicates a 6.37X 3-year average earnings multiple, owing to a more conservative target here.

Prudential Financial – Bulls & Bears

white and brown cattle

(Source: Unsplash)

The bullish thesis for Prudential nearly writes itself. We’re talking about a potential positive annual return, even if the company were to trade lower going forward than it does today. This upside only expands more the higher multiples we’re looking at, but given that we’re entering the investment at such a low multiple, the upside is good in nearly every scenario.

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The company’s fundamentals combined with high dividend safety, excellent capital structure, low debt, and positive expectations mean that there is very little downside potential, regardless of the type of scenario that occurs here.

All that the bullish thesis requires for successful execution is either a flat development or even just a slightly positive development. I wouldn’t necessarily call a negative development a good result, even if returns would be positive here, but it’s important to note that losing money here in the long term is something that seems very unlikely indeed.

brown bear sitting on grass field

(Source: Unsplash)

This makes the bearish thesis a complex one. The only scenario where a bearish view on Prudential becomes relevant, as I see things, is if we’re looking in the extremely short term, as in 2020. It’s not outside the realm of possibility that the company drops down somewhat again due to the pressured, full-year results.

However, outside this negative year, I have a difficult time forming a bearish thesis for the company. Prudential may experience more margin pressure as dynamics continue to favor more passive types of investing which drives investors away from the company’s solution, but PRU’s incomes are focused more on insurance than PGIM. The company’s emerging market focus may fail, which could drive the company back somewhat, but this would also only be a temporary sort of stall, unlikely to impact fundamentals all that much.

Therefore, the bearish thesis for Prudential is focused very much on the short-term thesis, which could mean that we may see a better entry point as we move forward.

Thesis

Prudential Financial is one of the best insurance businesses you can invest in. The company has proven its quality over the course of over a century, and the company’s fundamentals today continue to confirm this quality to this day. While Prudential faces a number of challenges in the near term, future trends seem more positive when earnings normalize and things continue going back to normal.

The positive here is the combination of fundamentals and an undervaluation virtually guaranteeing positive returns in a multitude of different scenarios. It’s exactly the sort of investment possibility that I look for when I scan for my weekly and monthly investments. Usually, a 7% yield is accompanied by a higher rate of risk than we’re seeing here, and far lower safeties in terms of credit and ratings as well as forecast uncertainty.

All the positives here mean that Prudential Financial is actually one of my primary choices for investment in the financial sector as things currently stand. It’s not as “safe” as Reinsurance Group of America (RGA), but it’s still orders of magnitude safer than other, lower-quality investment potentials.

That, coupled with fundamentals and valuation, makes the company a “BUY” here.

Thank you for reading.

Stance

Due to a 40-60% Undervaluation, Prudential Financial is a “BUY” here.

Disclosure: I am/we are long PRU, RGA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment.

I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles.



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