Thesis

As I intend to retire from sports in around 6 years, my main investing goal is to generate another income stream through dividend payments. My full portfolio that will help me achieve that goal is public here.

Due to the relatively short investing time horizon, I tend to look for higher-yielding stocks, to generate meaningful income straightaway. Some investors immediately discard high-yielding dividend stocks as they see it as too risky of an investment.

Whilst a double-digit yield usually means that the price has crashed due to some thesis-breaking developments, yield on its own doesn’t really tell us the whole story. It’s just a function of the current share price and the current yearly dividend.

There are great opportunities for income investors when a company that is fundamentally strong and can afford its dividend, is not popular amongst market participants.

You can’t buy what is popular and do well

– Warren Buffett

Prudential Financial (PRU) is one such opportunity. The company is fundamentally strong and keeps rewarding shareholders with increasing dividends from its growing profits. The stock price was already declining pre-Covid due to the low interest-rate environment and has been punished further by the pandemic. For patient investors, the current valuation represents a great buy opportunity for growing dividend income and potential for significant share price appreciation.

The Company

Prudential Financial Inc. is a diversified insurance company offering a broad variety of life insurance, annuity, retirement plan and asset management services. The company has operations in 40 countries, employing ~50,000 people.

Source: Q3 Investor Update

Dividend

The current dividend yields 5.8%, is well-covered by earnings and has been growing at a very impressive pace.

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PRU did cut the dividend in 2008, but that was due to a Fed requirement – not poor business performance. The dividend would’ve remained covered by earnings even through the Great Financial Crises.

The dividend has grown rapidly since ’08. The company is on solid footing and can comfortably cover the dividend. The latest dividend raise came in at 10% in the start of the year.

Even during this year’s challenging times, PRU is covering its full year dividend with a very safe 49% payout ratio.

Source: Prudential Q3 Investor Update

The company has also historically rewarded shareholders through buybacks. Unfortunately, buybacks were suspended in Q2 of 2020 until the company has better visibility of the financial conditions going forward.

This is what the CEO had to say on the subject during the latest earnings call:

In line with the risk framework that we have in place, we paused share repurchases in the second quarter. But it’s really about this, until we have better visibility into the depth and the duration of the pandemic, a possible recession and the credit cycle, which still may be before us we’re going to maintain our financial flexibility and the resiliency. And when we get clarity into those issues that I just mentioned, we’ll share the timing with you of our plan to resume share buybacks, and by how much. But until then, we’re going to focus on maintaining our financial strength with many of the unknowns still in front of us.

– Charlie Lowrey

Balance Sheet

Source: Q3 Earnings Report

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The company has ample liquidity on its balance sheet through cash in hand and undrawn funds on its credit facilities. As of the latest earnings report, liquid assets amounted to $6.1 billion.

PRU managed to pre-fund $1.5 Billion worth of 2020/21 debt maturities and is in a strong position to withstand this uncertain economic period. Long-Term Debt/Capital ratio is a conservative 21%.

Prudential has earned an A credit rating from both S&P and Fitch.

Valuation

Although the share price has appreciated impressively since bottoming in March, PRU is still trading at an attractive valuation. The current share price of $75.4, represents a blended P/E valuation of just 7.5.

Some will not want to buy shares that were just trading significantly lower a few months ago. As seen on the F.A.S.T Graph below, shares are still undervalued compared to historical valuation and current growth prospects.

Source: F.A.S.T Graphs

For shares to revert to the last 10-yr historical valuation of 9 P/E, it would represent an upside of 17%. Add to it the generous dividend and projected earnings growth, and PRU offers a potential of great returns over the coming years.

Source: F.A.S.T Graphs

Risks

Low interest rates mean that insurance companies make less money off their float. As insurance companies usually invest a large % of that money into bonds – the lower the rates, the lower the returns. However, that’s just one part of earnings for insurance companies – the majority of earnings for the insurance segment still comes from fees. Additionally, the PGIM segment doesn’t depend on interest rates.

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This is what Vice Chairman Rob Falzon had to say on the subject of low interest rates in the Q2 earnings call:

With respect to interest rates, we’ve successfully managed through decades of low interest rates and other market challenges in Japan. As you have seen us do in the past, we adjust our product offering quickly to meet the needs and preferences of our customers, while also achieving our return expectations. We have already taken actions and will continue to do so as needed as we move forward.

Covid-related risks still exist. The company estimates that for every incremental 100,000 US Covid fatalities, PRU’s operating income may decline by roughly $70 million.

Summary

PRU’s current valuation offers investors a chance to buy an out-of-favour stock with strong fundamentals. Patient investors can lock in a 5.8% dividend that is well-covered plus strong potential for share price appreciation as the company grows its earnings and the market reverts to PRU’s historical average valuation.

I rate shares a “BUY” at the current valuation.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.



Via SeekingAlpha.com