Upside Potential for Principal Financial Group - Barron's

| About: Principal Financial (PFG)

Battered along with the rest of the life insurance sector, Principal Financial Group (NYSE:PFG) has been unduly punished, writes Barron's Leslie P. Norton. Investors could see shares rise 50% within a year.

The bad news first: Though the stock rallied April 8 on reports TARP would be extended to life insurers, that same prospect has spooked many investors concerned TARP aid would heavily dilute earnings for current shareholders. Other investors are worried about Principal's investment portfolio, which includes commercial real estate loans and mortgage securities. The company reported 2008 earnings fell 47%. Moody's changed its outlook on the company to negative, while Fitch gave it a downgrade. On top of this, Principal has $455M of bonds maturing in August. Analysts expect Q1 earnings, due out May 5, to be just $0.66/share.

Yet despite all of the above, Principal's shares have had more than their fair share of punishment already, making the stock worth a second look. It's unlikely that all the unrecognized losses in the company's portfolio will be realized. The stock trades at a conservative estimate of its book value. Principal has an attractive money management business and, unlike many peers, isn't exposed to the dangerous guarantees that accompany variable annuities. It's also a leader in 401(k) retirement plans, a sector that will continue to grow.

Principal has hinted for months that it would accept TARP aid, a move that some analysts believe would dilute earnings by 7.8% this year and by 27% in 2010. Not all investors think this is a bad thing. "If they take the TARP money, it could dilute long-term earnings by 25% to 40%," admits Mark Henneman, a portfolio investor at Mairs & Power, "but I still have plenty of upside, especially if I have conviction there's enough capital to get them through the storm."

Sanford C. Bernstein analyst Suneet Kamath suggests Principal doesn't need to accept TARP money at all, and could instead cut its annual dividend of $1.80 and lower operating expenses. As of February, it also had $800M of excess capital.

  • Bank of America/Merrill Lynch analyst Edward Spehar noted at the beginning of April that Principal's "economic book value under a stress-case scenario is $13 to $14 per share. We think [Principal] is extremely compelling at 60% of economic book," and downside is 'limited' as the company makes an attractive acquisition target.
  • Bernstein's Kamath thinks Principal's shares will outperform the S&P 500 in the next 6-12 months by more than 15%. He has a $22 target for the stock, a 50% bump from where the stock traded last week.


  • Principal Financial Group: Q4 EPS of $0.69 beats by $0.03. Revenue of $2.53B (-12.8%) vs. $2.69B. AUM $247B vs. $311B last year. (PR)
  • While Principal Financial Group's Q4 earnings were generally in-line, it's 72% drop in book value - more than twice the peer average - was not, analysts said. "Potential for a capital raise cannot be ignored as management continues to underestimate strain from investment portfolio," noted Citigroup.