Company description:

Legal & General Group Plc (OTCPK:LGGNY/OTCPK:LGGNF) provides various insurance products and services internationally. The business is listed in the UK and is a constituent of the FTSE 100. L&G was founded in 1836 and is headquartered in London, the United Kingdom.

L&G operates in four segments:

• Legal & General Retirement (LGRI) – Services include annuity contracts, lifetime products and retirement schemes.
• Legal & General Investment Management (LGIM) – Services include index and active fund/equity management and, more generally, asset management services.
• Legal & General Capital (LGC) – Services include investment strategy and implementation, and direct investment and structuring services.
• Legal & General Insurance (Retail)- Services include a range of traditional insurances offerings.

Through one avenue or another, L&G covers the majority of insurance services and asset classes, seeking to be a generalist financial services expert.

L&G’s shares have traded sideways for much of the last 10-years, with little in the way of noticeable catalysts or significant operational changes.

The business currently offers an attractive 7.2% dividend yield. With current market conditions worsening, investors are increasingly looking for a safe heaven and sustainable returns. The purpose of this paper is to assess if L&G could offer this, with a view for what the long-term may look like for the business.

Macro view – Economy and industry:

With L&G generating income from different financial services segments, we have assessed the market conditions of each and L&G’s relative performance, beginning with a broad economic overview.

Economic considerations:

Market conditions have turned bearish in response to the changing economic conditions globally. Inflation has risen sharply; the Russian invasion has disrupted the energy market and China’s failed zero-COVID policy has continued to disrupt supply chains into 2023. The economic response to this has been to increase interest rates, with the intention of cooling demand.

Going forward, interest rates will likely need to rise further, limiting demand and potentially triggering a recession in weaker countries. The US has shown early signs of inflation falling but several more months of heightened interest rates will be required.

This means that markets could have another tough year, with continued bearish sentiment. This cements the importance of ensuring L&G’s dividends are sustainability as being able to lock in a 7% return today could be highly lucrative.

Insurance and Retail (Retail):

When considering a recessionary environment’s impact on the insurance industry, we expect the following developments:

• Demand for supplementary services v. required – Demand for insurance products differs between core services and add-ons/non-core. Recession or not, an individual requires home insurance, car insurance etc. These are inelastic in demand. That said, add-on services and upselling options are less likely to be taken up, as consumers look to save small amounts where they can. Further, they are also more likely to shop around when renewals come around. This creates greater competition in the market, making it harder for L&G to achieve growth.
• Pricing competition – With competition heightening, insurances companies will look to be more price competitive. It is a market where differentiation is difficult, and many look at price when making decisions. The Association of British Insurers has found average home insurance prices have fallen 7%, contents insurance 11% and motor insurance 5%. This will contribute to tightening margins in the near-term.
• Premium reinvestment – Weakening economies lead to struggling markets. This results in reduced returns from investing premiums received. Again, this is a margin compression mechanism. Insurance companies will look for other opportunities to invest but the reality is that near-term returns cannot be saved, as most investments move with the market. For this reason, there is greater pressure to cut down on unnecessary expenses and settle claims efficiently.

Impressively, L&G’s retail business has grown 14% when compared to H1 2021, with profits doubling. This doubling is as a result of government yields increasing in both the UK and US, distorting the numbers. Genuine business improvement can be observed in GWP growth, which stands at 7%. COVID-19 mortality in the US remains a drag, with a claims provision of £57M set up at year end.

Further, L&G has grown to being one of the largest players in the space, having the ability to leverage market knowledge and expertise to remain highly competitive.

We see strong evidence in this product mix to suggest growth in line with inflation is a minimum, with scope for outperformance. L&G highlight Fintech as an area for growth but the sector is going through a period of consolidation, with much weakness.

Asset management and origination (LGIM & LGC):

As we have mentioned previously, markets are currently experiencing a decline. L&G’s asset management services predominantly comprise pension management. This is important to acknowledge as the business does not face any material redemption risk and is highly diversified across asset classes. This is observed in their AuM bridge below, with net inflows being driven by UK and international pensions. A nuance here is that we have seen large wage inflation in the last two years, which could drive medium-term outperformance, as markets have not priced this in.

This said, market weakness can be observed by the small wholesale inflow amount, but L&G continued to be a top 3 receiver of UK retail money in 2022.

LGIM’s financials look fairly healthy, with only a 2% decline in operating profit. AuM has of course fallen quite dramatically, but this is not something large, diversified asset managers can avoid. What is key to observe is the net flows and profit figure. Based on the bridge above, a 9.2% fall in AuM resulted in only a 2% fall in operating profit, which is fairly good economics if we consider downside risk in 2023.

Management is continuing to focus on three main pillars: Modernisation, diversity of offerings and internationalisation. When considering key themes in the asset management space, we have observed a requirement of AMs to show ESG values. EY found 26% of investors decided against an AM because of inadequate ESG policies. This is an area in which L&G score extremely high and as mentioned, is an area of continued focus. Further, we are seeing digital investment across many “traditional” industries, as consumers seek better and more streamlined services, as well as companies seeking better back-end services. Again, clear investment from L&G in these areas is great to see, showing their long-term view on the growth of the segment.

LGC has outperformed even this, with operating profits up as AuM has fallen.

This has been as a result of alternative assets held and developed in the last few years. L&G has expanded heavily into alternative assets, through acquisitions, partnerships, and greenfield investment. The most important theme in modern day asset management is alternative assets, their popularity has grown tremendously, and we are very bullish. For a more extensive write up of our views, see our thoughts on KKR and Blackstone.

L&G are forecasting LGC AuM to grow to £30BN by 2025, and operating profits of £600-700M. They are currently on track for this. With LGIM being a highly mature business, management’s forecasts focus on the qualitative factors across the 3 pillars.

Overall, we are very impressed with L&G’s asset management segments. They are clearly focusing on the key industry themes, ensuring L&G remains at the forefront of money management.

Retirement solutions:

As with the rest of the business, LGRI has also grown. New business stands at £4.4BN, with healthy operating profit growth. AuM has dipped, however, as a result of greater interest rates.

Further, the business has found much growth in PRT, which is the process of de-risking a defined benefit scheme for the employer. L&G believe they can grow this to a £60BN business internationally, with a pipeline of £25BN into 2023.

Growth in this segment reflects changing demographics in key markets as consumers move towards retirement. There is some direct risk for L&G in servicing annuities. The business has 2/3 of its AuM in A rated assets or higher, with all cash flows paid and no defaults. Since 2007, their default rate has been <1bp. The business remains well within all solvency ratio scenarios and the balance sheet is positioned to withstand a credit event.

Assessment of the market and current performance:

Overall, the business has shown great resilience in the face of weakening market conditions. Management have shown countless strong qualities in their strategy to grow long-term, be it with the expansion of PRT, investment in alternatives etc. Given that we have visibility on H2’s macro view, it is fair to say things will weaken. That said, nothing observed yet suggests the business will struggle in supporting dividend payments or see an abnormal fall in operating performance.

Solvency II requirements:

As observed, the business maintains a healthy surplus of c.£9BN.

Historical financials:

L&G’s historical financials paint similar picture to its recent performance. EBITDA (although less useful) and net income are both growing at a very healthy level, with margins improving almost consistently across the historical period. FCF has shown volatility as a result of movement in trading assets, but this has not compromised L&G’s ability to pay dividends.

Dividends have grown an at an impressive rate of 10% across almost 10 years, even during COVID-19 (although one payment was paused).

The general trend is positive and shows recent developments are not one-off, but part of a wider strategy of continued improvement.

Peer group and relative value:

When comparing L&G to its peer group (a handful of diversified insurance businesses, not necessarily identical services), we believe the business is in the “above average” category. The business is more profitable, forecasting greater growth and is paying greater dividends. Yet, the business is trading at a noticeable discount. It is no surprise that a mature business like this has an analyst estimate upside of over 20%.

Our belief is that L&G can reach an EBITDA multiple of 16-18x, where it traded at between 2018 and 2021. This suggests an upside of c.24%. Contributing factors to this are continued steady retirement business growth and greater asset management performance when markets improve.

Based on this, it is difficult not to recommend L&G. Investors could choose to wait for FY results on the belief that (likely) weaker numbers will bring the stock down further, but we believe it is an attractive proposition today.

Conclusion:

Overall, L&G has grown its profitability consistently and sustainably for many years, with boring long-term decision making. The business is not doing anything revolutionary but is making all the right decisions to continue in a similar vein.

In its current position, we believe there is upside for capital appreciation and continued dividends in excess of 5%. The stock could fall on FY results, but equally a performance similar to H1 could lift the stock. It rose 5% in the week following H1.

We rate this stock a buy.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.