Prudential Financial, Inc. (PRU) has a very good 4Q 2016.Let's take a look at the quarter data and then think about how to approach the stock in 2017.
Here are the key numbers:
4Q ROE was 12.6% and the company showed strong y/y growth in its two U.S. divisions. Pre- tax income at Retirement Solutions and Investment Management was $964m vs. $776m 4Q'15 and Individual Life and Group Insurance was at $181m vs. $126m 4Q'15. The International Division was OK, with $755m vs. $738m 4Q'15, and reflects some FX pressures due to the strong dollar. Underlying operating income after tax for the quarter was $1.09bn vs. $891m a year ago.
This is the development of earnings in the Retirement division over the last five quarters:
PRU reduced its average weighted shares by just under 4% on a diluted basis over the year, so the underlying operating performance for 4Q was for a 22% rise in the bottom line and this rose to 26% thanks to a lower share count.
The idea on PRU here at FIG Ideas is that the company will make at least $10 of operating EPS in 2017 and investors should enjoy 6-7% EPS growth. We got $9.14 OEPS in 2016. Assuming a further 4% EPS growth from buybacks in 2017, we need to find 5% organic growth to make our EPS for the year.
The company's guidance range is $10.15 and $10.65 for 2017; 3Q 2015 was a weak quarter so there is little to worry about for this year given that the main engines of the group are all firing just fine.
What should investors think about then? It's not valuation. At sub 10x EPS and with a 7% capital return coming from a 3% yield and 4% buybacks, the economics at PRU are attractive. Although it's been a volatile ride over the last five years, the stock has modestly outperformed the SPX (orange vs. blue lines on the chart below).
With the outlook favoring rate hikes at more frequent intervals the stock should continue to outperform and investors should weigh the general idea that higher rates will be a constraint on S&P earnings for the most part (if nothing else via the FX channel) but will be positive for PRU.
The yellow circles on the chart show periods where the stock has suddenly dropped and been much worse than the SPX. The first is the taper tantrum, the second is the end of tapering (October 2014), the third is the Chinese slowdown in mid 2015 when Fed tightening and pressured commodity prices were also features of market dialogue and the fourth was the final stage of the oil collapse in early 2016, which followed from a Fed hike in December 2015.
But PRU enjoys higher rates, so why were the moves towards higher rates around tapering and the 2015 discussion then delivery the first hike a problem? It relates to how financial stocks behave when financial conditions tighten suddenly. I have seen this many times and can't always fully explain it. After all, as Ben Bernanke tried to say when markets tanked in reaction to his mentioning tapering in May 2013, it was a good thing if the Fed could reduce its purchases due to conducive economic conditions and we can say the same about the Fed looking at hikes now.
Whether we blame human psychology or momentum following algos for the periodic jumpiness of this stock, what matters for long term investors is that its ROE delivery has remained strong through the gyrations in the share price and vs. the SPX the PE discount provides comfort as well. The real fundamental risk is that the Fed can't raise rates as quickly as the market expects due to dollar pressures, especially if China experiences another period of economic slowing (which seems inevitable given the role of stimulus in the recent firming).
In my recent article on Chubb (NYSE:CB) I said that CB had slightly gotten ahead of the 10x EPS and the 1x BV I like as an add point for insurers (that stock remains a strong hold by the way). PRU still offers that kind of entry valuation for anyone with the space in their portfolio. The FIG Ideas US Financials Portfolio already has a >6% position in the stock but will nibble on pullbacks.
Disclosure: I am/we are long PRU.
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.