Give the market what it wants and good things can happen... at least in the short term. Prudential PLC’s (NYSE:PUK) (“Pru”) decision to accelerate its demerger from Jackson National, its U.S. life insurance operation, has lit a fire under the shares, sending them up more than 30% since the late January announcement. With Jackson National off the books, Pru management will be free to dedicate all their time, attention, and capital to the faster-growing, higher-margin Asian markets where the company already enjoys a solid business.
I like the move to accelerate the split, though I do find management’s decision to raise equity in order to pay down debt much more questionable. Long term, I like the growth opportunities in Prudential’s top markets across Southeast Asia, not to mention growth opportunities in China and India. The shares aren’t a huge bargain today, but I think 10% long-term core earnings growth is possible now, and I think that can still support decent total returns from today’s price.
Sometimes Good Things Come To Those Who Don’t Wait
When I last wrote about Pru, the company was already in the process of separating itself from Jackson National, but the company was still considering a more measured exit strategy centered around an IPO. Since then, and since a meaningful revision to hedging assumptions within Jackson National significantly impacted the RBC ratio, management has decided to accelerate the process.
Pru is now going to pursue a demerger, basically a spin-off, in which Pru shareholders will get a share of the new Pru and a share of Jackson National. Pru will retain a 19.9% stake in Jackson, but with the intention of selling half within a year and most likely disposing of the remainder not so long after.
Management will be raising debt within Jackson National, but it will not benefit the ongoing Pru Asian operations.
A Stock Leveraged To The Growth Of The Middle Class In Asia
Once the split is complete, Pru will be an almost-pure play on Asia’s life insurance markets (there's a small, growing Africa business as well), where rising personal/household income correlates very strongly with increased interest in savings and protection products. Unlike the life insurance products most U.S. readers will be familiar with, Pru’s policies in Asia are largely unit-linked savings products where the policyholder assumes the risk and where various riders (health insurance, income protection, et al) can be attached in exchange for extra payments.
Pru has a strong business across its China-to-India footprint (the company does not compete in Japan or Korea). Hong Kong is the largest market in terms of Annual Premium Equivalents (or APEs), with HK making up about 39% of pre-pandemic APE, and it’s a very profitable market (25% of pre-pandemic operating profit). Government restrictions on Chinese citizens buying policies in Hong Kong will reduce the addressable opportunity, but it’s still an attractive market where Pru enjoys #3 market share among foreign players and #5 share overall (7%, with China Life (LFC) #1 at 20%).
Indonesia is a disproportionately profitable market for Pru, with about 8% of APEs and 19% of operating profits, and management views Indonesia as a key growth market. In addition to population growth and household income growth, Pru has been leveraging strong product development, introducing numerous new products in 2020 and focusing on developing sharia-compliant products for the market, and the market is still barely penetrated.
Rather than go country by country across all of Pru’s markets, I will just note that Pru also enjoys strong share in attractive markets like Singapore, Malaysia, and Thailand, and is also paying a lot of attention to growth markets like the Philippines, India, and Vietnam. In none of these markets is insurance penetration beyond the mid-single-digits (most of them are in the low single-digits).
China remains a subject of debate and controversy. China generates close to 10% of Pru’s Asian profits despite having only <1% share (they’re the #24 player). The debate and controversy revolves around Pru’s intentions and ability to buy out its joint venture partner CITIC (OTCPK:CTPCY). While such a move would be appealing for several reasons (including Pru having full autonomy/control), the cost of such a buyout likely exceeds Pru’s capacity for at least a few years.
Improving Margins, But An Odd Choice
Pru recently reported second half earnings, and those earnings saw a more or less as-expected decline in Asia APE (down 22% yoy, down 22% hoh). Hong Kong APE was down 61%, but the rest of the Asian business was flat, with China up 4% yoy.
APE margin, though, was meaningfully better than expected, improving about nine points from the first half to 63.5%, and new business profits rose 41% hoh to $1.29B, while operating profits improved 13% hoh to $1.79B. Higher profitability was driven by a shift toward higher-margin protection products, likely a result of the pandemic, and it remains to be seen if this shift will endure (I’m assuming it does not in my model).
The “odd choice” I refer to involves management’s announcement that it will raise $2.5B to $3.0B in new equity capital after the demerger. Management said that they intend to do this to both increase the stock’s visibility/liquidity with Asian investors and pay down debt. While the former makes some sense, the latter seems foolish relative to simply refinancing the debt at today’s low interest rates. I would prefer instead, then, to see a more comprehensive debt refinancing and perhaps a more modest equity raise, with that capital used to fund growth across the Asian business footprint.
The Outlook
I believe the Asian insurance operations can generate long-term core earnings growth in the low double-digits with a mid-teens ROE. Growth will be driven largely by increasing insurance penetration in markets like Indonesia, China, Thailand, and India, as these markets still have single-digit insurance penetration today, as well as some market share growth in markets like China.
Capital returns will likely be relatively limited for several years after the split, as I believe management will want to retain as much capital as possible to support the growth of the business (and possibly the JV buyout). Adding in the value of Jackson National, and I’m using a 0.35x multiple to book value, which I think should be conservative, I get a fair value around $45 today.
The Bottom Line
I realize that a $45 near-term fair value isn’t terribly compelling, but I do think that double-digit earnings growth will drive double-digit total annual returns, with Pru likely to close at least some of the valuation gap with AIA Group (OTCPK:AAGIY) over time. Even for investors who don’t find the current upside compelling enough, I would recommend this as a watch-list name.
