Description

Prudential Financial, Inc.
Symbol: PRU
Date: 12/13/04
Price: $ 52.00
Market Capitalization: $ 26.57 B
’04: $ 3.40; 15.3x
’05: $ 4.50; 11.5x
’06: $ 5.20; 10.0x
’07 $ 6.00; 8.7x
Dividend: $ 0.625
Div. Yield: 1.2%
Book Value: $ 37.00
FCF ’05 1.25 B; FCF yield: 4.7%


In the exactly three years since PRU’s ‘de-mutualization’ driven IPO, the stock has doubled – a monstrous out-performance relative to both the S&P500’s roughly 5% point to point price change and practically any company with whom PRU might reasonably be compared. Yet, a compelling case can be made that the stock retains very significant appreciation potential in the context of exceptional risk/reward.

PRU is the 4th largest market cap in the insurance space(AIG, ALL, MET) and 18th largest in the S&P Financials Index. In contrast to the three aforementioned insurance names, PRU has no exposure to property and casualty lines of insurance, but rather is focused on life insurance, investment management, and retirement/savings. By segment/division, the Company is organized as follows: domestic insurance(life insurance and annuities) – 32% of pre tax; investment management(asset management, retail brokerage, and retirement savings) – 27% of pre tax; and international(life insurance – overwhelmingly in Japan) – 40% of pre tax.

The catalysts for the stock’s appreciation to date have been multifold, but all related to management near flawless execution of a plan outlined three years ago to dramatically raise the ROE of PRU to 12% in ’05 from 6.5% at the time of the IPO. This was accomplished through a massive redeployment of a combination of both under-earning and excess capital via: divestiture of businesses; joint venture of others; opportunistic acquisition of other businesses, 3.5 B of share repurchases and other steps to optimize the Company’s capital structure. As a result, the 12% ROE goal is visibly in hand and management has earned a well deserved reputation for trustworthiness, financial discipline and strong orientation toward the creation of significant value for shareholders.

If the above is the story of the last three years, what is the story of the next three years?.
Simply put, more of the same and taking it to a higher level. On December 2nd, PRU endorsed $ 4.20 – 4.40 of ’05 e.p.s(and, in doing so bracketed the consensus expectation of $ 4.30). The guidance is based on a number of obvious building blocks off the $ 3.40 '04 but excludes a number of less obvious building blocks. I have had, and again have, little difficulty getting to $ 4.50 and this before assumption that any 'of 04's hefty 200

MM pre tax litigation expense goes away or consider a couple of other - al beit smaller - factors. This may not be a complete sandbag, but its close enough for me. And, CEO Ryan seemed to implicitly acknowledge as much in saying "Though we wouldn't want to be accused of setting the bar so low we could cross w/out any effort, we also don't mind being accused of conservatism.". Thus, I see PRU continuing a string in which it has consistently set expectations that, barring circumstances truly outside of management control, will almost certainly be exceeded. More importantly, PRU set an ROE target of 14% in ’07. The building blocks for achievement of this industry leading level are several fold. However, the transformation of PRU over the last couple years has resulted in a richer, faster growing, more profitable business mix. For example, the International business, which is 40% of earnings is growing at a double digit clip w/ ROE in excess of 20% and , given growth rate differential with PRU’s other businesses, should be a greater contributor to total in the future. In addition, PRU still has an estimated 3B in capital that will be redeployed. Furthermore, PRU should generate in excess of 1 B in FCF per year which almost certainly will be directed to ongoing significant share repurchases. As a result, I see PRU going on to earn in excess of $ 5.00 in ’06 and $ 6.00 or more in ’07.

Should PRU deliver on this promise, a reasonable upside expectation over 18 months is $ 70, or 11.5X (i.e. a conventional life insurance multiple) ’07 earnings. At the same time, given the likely strong upward trajectory of earnings and profitability, it is hard to see PRU trading below, say, $ 46-48, i.e. a modest 1.25-1.3X multiple of its current $ 37 high quality relatively un-leveraged book value, especially when also consider the support which, theoretically, should be offered through 6% ‘cash/cash’ yield provided by the combination of the dividend and certain 1.5 B in share repurchases. Thus, see strong, 35%, absolute upside in context of 10-12% downside and resulting 3/1 or more risk/reward profile. Moreover, believe it is possible PRU could achieve a higher valuation should there develop greater understanding of, and appreciation for, the attractiveness of business mix, its relative growth prospects, the quality and shareholder orientation of management, and PRU’s superior e.p.s. and profitability trajectory. It may not be hyperbole to say that there may not be another large capitalization financial stock out there which will experience both very strong increases in earnings AND profitability over the next couple of years. That PRU remains under owned by institutional investors is, at the margin, an additional positive.

Catalyst