Legal & General Group PLC (LON: LGEN) – Sustainable business model and robust balance sheet position

Legal & General Group PLC is a FTSE 100 listed Company, which provides financial services across the UK, and the US. The Company operates with four business segments - Legal & General Retirement (which manages individual retirement, and pension risk transfer business), Legal & General Capital (manages direct investments, and treasury assets), Legal & General Investment Management (which caters to retail and institutional investment management and workplace savings businesses), Legal & General Insurance and General Insurance business (deals in personal insurance needs). The Group is one of Europe’s most successful and biggest asset managers, with £1 trillion of assets under management. It is also a market leader in the UK for life insurance, bulk annuities, and other retirement products. The Company has offices in Europe, US, and Asia, which supports diverse sectoral and geographic distribution of assets.

 (Source: Presentation, Company Website)

Dividend Distribution

In H1 FY20, the Company declared an interim dividend of 4.93 pence per share, which was in line with the prior year, reflecting the business resilience amid Covid-19 led disruption. The last dividend payment date was 24 September 2020.

For FY20, the Company expects to keep the dividend flat due to challenging trading conditions. Over the next five years, it intends to distribute GBP 5.6 to 5.9 billion. From FY21, the Board intends to grow the dividend at low to mid-single digits. From FY20 to FY24, EPS is expected to grow faster than dividends. Over the longer term, Legal & General expects to maintain its progressive dividend policy reflecting the Group's underlying business growth, including net release from operations and operating earnings.

Industry Outlook Dynamics

As per the publication from Research and Markets, the market size for global life insurance providers is expected to grow to US$3,586.96 billion by 2022 from nearly US$2,951 billion in 2018, representing a compounded annual growth rate of 5.0% during the period. The fundamentals of the industry remain strong with several growth drivers, such as increasing ageing population, climate change, and globalisation of the asset market.

Growth Prospects and Risk Assessment

The Group is a market leader with over 20% market share in UK Retail Protection insurance. The breadth and depth of resources underpin the strength of their business model. The Group has been a trusted brand for 200 years, which has a long-standing relationship with numerous clients. It has an established track record of consistent growth in operating profit across all divisions, and the further upside potential is supported by incremental growth in new businesses. Moreover, the Company is investing continuously in technology to become a digitally enabled insurer. The Group is focused on innovations and new techniques to deliver improved services and long-term value. It has a strong financial discipline, which helps the Company to have a robust and effective balance sheet. The Company has been focussing on improving customer support, which has resulted in a higher level of customer satisfaction. Investment in future business helps in achieving further sales growth and operational efficiencies. The Company has an active management approach to deal with the default risks. LGEN continues to invest in technology, and its balance sheet remains robust, with a steady increase in the surplus regulatory capital.

In H1 FY20, the Company declared an interim dividend of 4.93 pence per share, which was in line with the prior year, reflecting the business resilience amid Covid-19 led disruption. Over the longer term, Legal & General expects to maintain its progressive dividend policy reflecting the Group's expected underlying business growth, including net release from operations and operating earnings.

However, the Group’s performance is subject to some principal risks and uncertainties as the volatility in market conditions can adversely impact earnings and profitability. Moreover, legislative changes and new entrants can disrupt the market environment. The material failure in IT security and business processes can cause reputational damage and unanticipated financial loss. Further, the emerging threats of climate change can significantly impact the investment portfolio. Also, to meet the new regulations, the Group needs to implement new processes, failing to do so would increase the compliance risk. Acquisitions to match rapid transformation may increase integration risks and expected synergies may not be achieved. 

After understanding the industry dynamics, we will analyse some key fundamental and shareholders statistics of Legal & General Group Plc.

Trading Update (as on 12 November 2020)

• In the year to date (till 12 November 2020), the Company has delivered a resilient performance, with a strong balance sheet and the Group's solvency ratio currently in the mid-170s (%) (which was slightly up from H1 20).
• Despite the challenging market backdrop, LGEN’s annuity asset portfolio has performed well.
• Moreover, the Company’s traded portfolio witnessed no defaults and just 0.8% of net downgrades to sub-investment grade as compared to approximately 1.7% for the index.
• The direct investment portfolio has received 99.5% of scheduled cash flows and also experienced no defaults.
• In Legal & General Retirement Institutional (LGRI), the PRT market has stayed active in 2020 and UK business has written £4.7 billion across 36 transactions year to date, with a strong performance in US business.
• Further, LGRI segment has shown good visibility and is actively quoting on a pipeline that exceeds £20 billion as well as expects an approximately £200 million LGR mortality reserve release at 2020 year-end.
• Despite significant market volatility, LGIM (Legal & General Investment Management) business has shown a resilient performance with AUM (Asset Under Management) of £1,234 billion and positive external net flows of £6.4 billion as at 30 September 2020.
• In Legal & General Capital, the housing sales have recovered, and Pemberton has reached €8.5 billion of committed capital. Further, FY20 residential housing sales are expected to be decreased by around 30%.
• On a year to date basis, LGI’s (Legal & General Insurance) gross written premiums increased by 5% in the UK and US.
• Legal & General Retirement Retail has continued recovery in individual annuity volumes, with a decrease of 10% year-on-year. While Lifetime mortgage advances decreased by 26% year-on-year.
• Furthermore, the Company expects IFRS profit on disposal to be approximately £325 million and has also completed the sale of the Mature Savings business.
• The Board is planning to grow the dividend at low to mid-single digits from 2021. Also, it intends to generate £8-9 billion both of cash and capital, and to dividend £5.6-5.9 billion.
• The Company has an objective for the period 2020-2024 are: Cash and capital generation to significantly exceed dividends, net surplus generation to exceed dividends and EPS to grow faster than dividends.
• Overall, LGEN expects operating profit in FY20 to be broadly in line with 2019.

Financial Highlights (for the six-months period to 30 June 2020 (H1 FY20), as on 5 August 2020)

(Source: Company Website)

• LGEN delivered a strong balance sheet, and resilient operating profits, with H1 FY20 solvency II coverage ratio of 173% and unutilised credit default reserve of £3.5 billion.
• For H1 FY20, the operating profit from continuing division decreased to £1,128 million (H1 FY19: £1,154 million), with 3 of 5 businesses delivering growth.
• Led by the consistent performance of the growing annuity portfolio, the LGR (Legal & General Retirement) operating profit increased by 10% year-on-year to £721 million.
• The Board had declared an interim dividend per share of 4.93 pence, in line with the previous year.
• The Company believes that the business is well placed to pursue upcoming opportunities in H2 FY20, supported by strong competitive positioning in growing and profitable markets.
• Overall, LGEN believes that the business is well placed to pursue upcoming opportunities in H2 FY20, supported by strong competitive positioning in growing and profitable markets.

Share Price Performance Analysis

On 11 December 2020 (before the market close, at 8.55 AM GMT), LGEN’s shares were trading at GBX 241.70, down by 2.97% against the previous day closing price. Stock 52-week High was GBX 324.70 and Low of GBX 138.00, respectively.

From the technical standpoint, 14-day RSI (35.24), 50-day SMA (222.50), and 50-day EMA (232.80) are currently supporting an upside potential, which means the stock price could increase in the short term.

In the past three months, LGEN’s share price has delivered ~ 24.93% return as compared to the ~9.05% return of FTSE 100 index, and a ~12.47% return of FTSE All-Share Life Insurance index, which shows that the stock has outperformed the benchmark index and the sector.

Valuation Methodology: Price/Book Value Approach (NTM) (Illustrative)

Business Outlook Scenario

LGEN’s consistent strategy has delivered 11% EPS CAGR since 2011. The Group has achieved five-year ambition of 10% EPS CAGR in just four years. Looking forward, it expects LGRR’s (Legal & General Retirement Retail) target market to continue to expand, driven by ageing demographics and welfare reforms. The Company has a strong new business pipeline to sustain the momentum of growth and profitability. The Group is anticipating a more sustained consumer demand for housing, which will strengthen the LGC (Legal & General Capital) division. The Board also highlighted that, notwithstanding significant market volatility, the Company’s Solvency position remained robust. In the long run, the Group will experience plenty of opportunities across pension risk transfer (PRT), defined contribution (DC) fund management, and affordable housing. Over the next five years, the Group intends to write £40 to £50 billion of UK pension de-risking business. The Company has shown a decent financial performance in the financial year 2019. LGEN has shown decent operational performance, robust solvency position, a strong pipeline of new business and the asset portfolio are performing well. The Group’s annuity portfolio continues to outperform markets, reflecting active asset management and thoughtful asset allocation approach being followed.

(Source: Presentation, Company Website) 

Considering the decent operating & financial performance, stable cash flows, intends to grow the dividend at low to mid-single digits, a robust balance sheet, and support from the valuation as done using the above method, we have given a “BUY” recommendation on Legal & General Group at the current price of GBX 241.70 (as on 11 December 2020, before the market close at 8:55 AM GMT), with lower-double digit upside potential based on 1.88x Price/NTM Book Value (approx.) on FY20E book value per share (approx.).

*All forecasted figures and Peer information have been taken from Refinitiv, Thomson Reuters.

*Dividend Yield may vary as per the stock price movement.

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