Description

Overview

Prudential PLC (Pru) was written up on VIC in 2019 by 85bears, after the separation of M&G. Pru was then left with two main assets, 

• Prudential Corporation Asia (PCA), a leading Pan asian insurance franchise with characteristics of structural growth driven by demographics and low penetration of health and protection insurance in Asia,
• Jackson National Life, a US focused variable annuities provider, with leading market share and good distribution capabilities.  

85bears argued that separating Jackson from PCA would unlock significant value for the group. Only a few months later, in early 2020, Third Point disclosed a position and Dan Loeb wrote a letter to the board asking exactly for that. He claimed that the creation of two standalone companies would have several benefits, including a better focus on distinct strategic and capital allocation priorities, elimination of central costs, and potential to recruit best in class management. The letter said that there was no strategic logic to the two divisions sticking under the same corporate umbrella, and lamented about a sleepy, London-centric, short-sighted management that prioritized dividends over reinvestment in a growing Asian business. 

Covid then hit, but Jackson was eventually spun off in 2021 and an experienced Hong Kong based CEO started in February ‘23, stressing a message of culture shift from a “holding company” to an “operating company”. Today, the crux of the investment case hasn’t changed much from 2020, but we haven’t seen the benefits yet: new management is yet to present its new strategy to the market (expected at the end of August) and started only some months ago, also, with covid the business experienced some volatility with roughly ⅓ of the business being impacted by lockdowns in China and Hong Kong until early 2023. 

However, in the last few years the company did undergo the transformation from a global holding company with assets in Asia, Europe and the US in different business lines, to being now a more focused Pan Asian health and protection insurer. 

Thanks to a trusted brand and great product and distribution capabilities, Prudential is well positioned to profit from long term fundamental trends of rising income and aging populations, which generally increase demand for life and health insurance products, with a long runway to grow, considering low penetration. The stock is currently trading on ca. 11x PE and 1x EV which I believe doesn’t capture the company’s growth potential. 

Brief business description 

After the separation from Jackson, Prudential is now a pure Pan Asian insurance business (with marginal exposure to Africa) that provides life and health insurance and asset management, the latter via its Eastspring asset management arm (AUM c.$220bn). It serves roughly 19 million customers in 23 markets. The company’s main strengths are an iconic brand with a long history, a moaty distribution network with leading competitive positions in its core markets with top three positions in 12 out of 13 life markets in Asia. Pru provides savings products including participating, linked, traditional products alongside fee earning asset management services and protection products and distributes these through an extensive agent network, banks and digital partnerships. All in all a diverse multi-channel and multi-product offering, which is mostly focused on the agency channel and health and protection products, with more than 50% of issued policies being health and protection plans. The agent-led model and focus on regular premium savings and protection products drives a higher retention rate (89% in FY22) and provides Prudential with a recurring stream of revenues.

In addition, compared to other insurers, Prudential generates most of its operating profits from underwriting earnings and fee earnings, and a small part from spread. Underwriting are pure “insurance” technical earnings which are “higher quality” as they’re highly predictable, similarly to fee earnings. Spread earnings on the other hand can be a less predictable source. Here’s a chart comparing different insurers on sources of operating income, from an old sell side primer:

The company’s end markets are structurally growing, helped by a rising middle-class and low penetration levels in health and protection insurance combined with high levels of out of pocket health and protection spending. 85bears in his write up had a couple of interesting charts, one showing life premiums growth and population growth, and another showing insurance and mutual fund penetration in Asia vs UK and USA, pointing to a growing market and a long runway. 

Allianz in their global insurance report that was published last May, has the following chart, with Asian gross written premiums growing at a double digit CAGR in the next decade to 2033. 

In terms of how Prudential’s business is split, here’s an overview in FY2022:

Quick parenthesis, for the non-specialists (I’m a generalist too and found that insurance jargon can be uninviting): “Par” means insurance policies where the policyholder is entitled a share of the company’s profits and surplus. For example, if I buy a life insurance policy that has a minimum guarantee of 1.5% and the separate managed assets generate a 4%, the extra profit will be shared between me and Prudential. In Non-Par products, the company keeps the surplus and gives me just the guaranteed return. H&P stands for health and protection, i.e. products that provide sickness or injury cover. Linked are products where the insurance usually doesn’t provide a guarantee and the underlying assets determine the value of the insurance: a unit linked can have an underlying equity portfolio (and lose money if the portfolio loses money, without the insurance company making up for the loss). On the top part of the table above, the acronym APE means Annual Premium Equivalent, a measure of business sales (this is calculated as the aggregate of annualized regular premiums from new business and one-tenth of single premiums of new business written during the period). NBP is a measure of profits, calculated in accordance with embedded value (EV) principles. EV is a way of measuring the current value to shareholders of the future profits from business written under a set of assumptions. For example, if today I buy a life insurance product that says I will pay a premium until I turn 75, the EV of that product would be the current value of the future profits from the contract. End of digression. 

In the last 18 years Pru Asia has grown its operating profits at a 15% CAGR from $378m to $4108m. 

Pru invested heavily behind this growth under previous CEO Mark Tucker in the 90s and early 2000s, creating a strong distribution network, expanding in different markets and setting the important distribution partnerships with CITIC in China and ICICI in India. The CEOs that followed Tucker (Tidjane Thiam first and then Mike Wells) had more of a “holding company” approach and prioritized dividends over growth opportunities. After a one-year transition period under former CFO Mark Fitzpatrick, the new CEO Anil Wadhwani has started in February 2023, after having been announced in May 2022. Mr Wadhwani brings a wealth of experience in Asian markets, having been CEO of Manulife’s Asia region for 5 years and previously having spent 25 years with Citi in various positions more recently as Global Consumer Bank Operations Head  and CEO Consumer & Commercial Bank, EMEA. The first time he reported to shareholders and markets said: “I am going to be meticulously focused on operational execution so as to fully capture the value from the opportunities we have ahead of us. This is the single most important priority for me and my leadership team”. I met him some months ago and he stressed the same message of culture shift from an “holding company” culture to an “operating company”.     

If we only believe the company can grow with its end markets, post tax operating profits pre IFRS 17 should grow to $3.2bn in 2023, $3.5bn in 2024 and $4bn in 2025, which turn into 11.4x, 10.2x and 9.2x PE ratios. This sounds pretty cheap for a business that is exposed to structural growth, with leading competitive positions and a renewed operational focus lead by an expert management team. Also we should consider that Pru’s agent business was damaged by covid lockdowns: HK is an important market, which also depends on demand from Mainland China Visitors (MCV) who travel to HK to buy cheaper insurance with better product choice compared to mainland China. With travel being disrupted by covid and lockdowns until early 2023, we should see a rebound from a low base. Covid however hurt not only demand but also the company’s distribution channel as agents were not allowed to visit customers and some agents stopped operating as they were not generating business.However Pru says that they’ve been able to motivate and activate agents and that 80% of the current agent force has joined before the pandemic (so the disruption is contained) and the reopening of the border is unlocking a recovery of the business and agent activity. I believe some sell side numbers are conservative on the HK recovery. 

In addition, recent results have been received badly by the market in mid-March, together with the timing of results being released as the market was digesting the news on SVB. Numbers were actually in line with market expectations apart from a lower than expected NBP margin in HK, which however could be explained with a technical issue (a higher discount rate used for the NBP calculation) and a likely temporary issue (agent force still disrupted at the beginning of the year and first MCV being mostly wealthier individuals buying lower margin savings products). 

Another current concern is the very recent application of IFRS17, which has an impact in terms of earnings recognition but importantly clearly no impact on fundamentals or cash generation, capital management, EEV valuation or dividend policy or strategy. Net net IFRS17 nominally decreases FY22 earnings for Pru by $650m (as guided) as now insurers are not allowed to recognize the value of future profits from life insurance contracts. This gets released overtime and in the meantime the value of future profits is stored in a liability called Contractual Service Margin (CSM). On the other hand the company has some visibility of future profits from the release of CSM. Pru just held a presentation and webcast on IFRS17 which does a much better job at explaining this than I could possibly do. Available here: https://www.prudentialplc.com/investors/results-centre

In terms of capital position, Pru is overcapitalised and comfortably above its risk appetite. The CEO said they could use some of this to accelerate inorganic growth but clearly didn’t give further details. (An option could be to increase its stake in the JVs in China and India).

Overall, at a low double digits multiple of pre-IFRS 17 earnings and roughly 1x Embedded value, Prudential looks cheap. The company has decoupled from its UK and US business and has an established competitive position, track record and clear growth opportunities and it’s lead by a new experienced management that is going to present its new strategy at the end of August with 1H results. As a reference AIA, Pru’s closest comparable, trades at a 40-50% premium on both PE and EV. 

Catalyst

1H results and strategy presentation at end of August