Fundamental Analysis of Legal & General - LGEN

I’ll be having a look at Legal & General. They recently had their full-year results which mean now is the perfect time to get some updated fundamentals.

“Improving lives through inclusive capitalism”

What Does Legal & General Do?

Before we jump into the analysis, let’s cover off what L&G does to general revenue. They are the UK’s largest investment manager, and among the 15 largest in the world, with more than £1 trillion of assets across its different businesses.


Source: L&G Full 2019 Report

Even before we get into the nitty details of each business line. It’s worth pointing out this is operating profit per division, which is already very impressive looking.

Pension Risk Transfer, this is all about annuities. When you enter retirement you can buy an annuity, this product will pay you a set amount each month/year until you die. The company takes an assessment of how long they predict you’ll live for, how much your pension is currently worth, and then offer a discounted but a guaranteed regular payout for you. As long as the discounts are deep enough, or they correctly assess life expectancy, this is a highly profitable business. This business line focused on bulk annuities, where it buys a “book” of annuities and thus takes on the risk.

Investment Management is the ongoing fees associated with buying funds. L&G has an impressive suite of investment funds. Over 50 different funds ranging from actively managed, passive trackers, fixed income, property specialist, to future themes like ESG or new energy.

Capital Investment Direct is all about direct ownership of larger long term investments. With over £16.3bn invested into UK infrastructure and a planned 80,000 homes by 2020. The projects are happening across Manchester, Cardiff, and Bracknell.

Insurance is what it says on the tin. L&G insurance is both for retail and part of the reinsurance structure too. L&G will take on insurance projects of all shapes and collect the premiums, taking the risk on the negative event not happening.

Finally, we have Retirement Solutions. Unlike the pension risk transfer, this business line deals with individual annuities, not buying a book of annuities to cover. Additionally part of the retirement solutions is mortgage advances, helping retirees paying off their mortgage or remortgaging their properties to free up some cash.

What About The Financials?

L&G is a very strong fundamental company, the real challenge comes with the high expectations the market has of their future returns. The recent COVID-19 outbreaks and insurance claims have damped the share price. Let’s see what that has done for the rating.


Source: Genuine Impact L&G

Out of almost 5,600 companies, L&G has come in #121 for overall quality. This is a very impressive feat. I expect financial companies to rank well for quality due to regulatory requirements around cash on hand but it’s worth seeing the raw numbers behind this to understand what this means.

Profitability isn’t as high as you would expect. Bringing in just below £2.1bn in profit before tax you’d be surprised to know they have left a lot of cash on the table. The profit margin is 9.28%, this leaves them a lot of room to make themselves more operationally efficient and one of the areas L&G can make a real difference in terms of growth. You’d hope they convert more of the £19.7bn in revenue they collected!

It should be no surprised L&G is a cash-rich firm, they have to protect themselves from the insurance payouts, and maintain strong cash flows.


Source: Wallmine L&G

Their liabilities to assets operate around 98% coverage, while expected this does mean the £13.9bn in cash and cash-like assets is very much required.

What I am interested in is the impressive dividend that L&G has maintained. Paying a dividend out since 1993 and currently paying a yield of around 8.5%, this might be the investment for any dividend lovers out there. The dividend has increased 11.3% over the last five years and 6.3% over the last three years. This is very much part of managements objectives and the focus for the business.

Paying out the shareholders is a key metric, which depending on your view could be positive or negative.

Are They Priced At A Good Value?

As mentioned paying out to shareholders has been a key target for management. Alongside this has been the various value ratios and keeping them balanced.


Source: L&G 2019 Full Results

By most measures, Legal & General is a very cheap and underpriced buy right now. I would take these numbers with a pinch of salt as this was managements objective as part of a five-year plan, rather than the natural market valuation of the company.

For me, this signals a great time to buy in while they move into a new strategy while keeping the shareholders at heart. This will likely free up more resources to pump up the dividend or even to increase operational efficiency. Maybe creep that profit margin up.

What Do The Sell-Side Analysts Say?

This is probably the most split sell-side I’ve seen in a very long time.

!


Source: Genuine Impact L&G

While they have missed the analyst predictions, I suspect this is due to their bigger focus on the company’s target rather than excelling against expectations.

However, you can see there several analysts saying now is the time to exit, a few who want to wait and see, and a slightly larger number looking to buy while it’s cheap.

So why do I think this is a buy?


Source: Genuine Impact L&G

Expected return means the share price increases in value, and expected growth is the revenue and earnings. A growing dividend and growing share price (target price) are absolutely what I am looking for. Increasing their revenue and earnings to meet sell-side expectations while exciting isn’t the be-all or end-all for L&G. Bringing in almost £20bn in revenue, converting that revenue into profit rather than trying to have another explosive growth of incoming revenue isn’t my concern.


Source: Market Beat Target Price

While the target has been decreasing as the share price has fallen, we are still looking at an average target price being 20% higher than the current price.


Source: Wallmine L&G

While the price has dipped and not fully recovered, the dividend for the current year has passed, giving us a clear runway for a recovery.

There have been a few warnings with COVID-19, however this is right now a wider market issue. Being in the insurance space this would have hurt L&G more than others, but with a foot in the investment space, they have been making their own cheap investments.

An ESG Friendly Buy

L&G also score very highly when it comes to their future innovations and investments into a cleaner, fairer future. I don’t truly believe everyone at L&G thing they are a force for good. I’m not expecting their staff to dress up as Batman and beat up Shell employees. Rather L&G knows they have the money to make a difference, and they make a targetted effort to make a difference in the world of tomorrow.

Personally, the increasing dividend and tasty 12-month target share price are what is driving me towards a buy stance, but it helps you feel all fluffy inside while you are doing it.

Let me know what you think of the analysis, do you agree or have another view? Anything you would want me to cover off or think is missing?

Thanks again for reading and enjoying the write-ups!

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Thanks for this, really interesting stuff. LGEN is one of the worst performing stocks in my portfolio at the moment, but I was struggling to see why.

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Because I the whole financials sector is typically one of the worst performing ones in a recessionary environment. Doesn’t mean the fundamentals aren’t solid for a company though, but it does imply that it may take a while to recover to its former strength - when it does, you may have found yourself a bargain, but treat with caution.

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Agreed with this. They have taken a real hit right now, being an insurer and taking on a lot of large pension risks, a market downturn and lots of unexpected payouts is the last thing you want.

They have been weathering it fairly OK, but if you already hold it I wouldn’t rush to get rid of it just yet.

Just be mindful that they are classified as an insurer, but the vast majority of their revenue and profits comes from pensions, pension risk transfer and investment management.

Life insurance will get some payments related to COVID but given their book it’ll be a drop in the ocean. People will continue to contribute to workplace and individual pensions regardless economic circumstances (unless you lose your job of course), and pensions risk transfer will benefit as if companies are facing financial pressure, they’ll likely be open to transferring their under funded pension out. The investment management arm is the 10th largest in the world I believe, and has a global footprint, so is also properly diversified, with most assets coming from institutional investors who have been with them for a long time and won’t pull the plug.

They are well diversified and strongly capitalised with a good solvency II ratio.

Out of the financial services sector, they are probably one of the best places companies to not just weather the storm, but benefit from it.

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