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Morningstar | Prudential plc Looks a Little, to a Middle, Bit Too Cheap

Prudential plc has been hit hard by the concerns around the global slowdown and in particular the slowdown of growth from Asia. However, the compression in the valuation is not a shock to us, and we maintain our GBP 16.9 fair value estimate and no-moat rating.

We have long been a bit concerned with the valuation of this business, thinking the market tended to price a premium for the quality of the business. This has been because it is one of the best-run life insurers that we have come across. Prudential carved out a niche for itself in the difficult to run business of variable annuities and proved itself to be the best operator in the business line time and time again. And when opportunities presented themselves, Prudential has taken market share from competitors that have run into financial underwriting problems. This has mainly been seen in the United States.

However, we think the valuation has previously factored in both growth and the high returns on equity of this more capital light business versus traditional fixed rate annuities, and the market has particularly liked the fee-based nature of this income. Adds-ons, or riders, can essentially be sold to keep "upping" this fee-based income that tries to make these products look closer and closer to fixed rate products but offering higher returns to policyholders, as is needed in the current low fixed rate environment in order to ensure asset longevity. But this is not a growth area anymore for the business, and that driver has been coming from Asia.

We think the market has revised down its growth estimate for the business by 150 basis points to around 5.0%, pulling the justified price/book valuation down from 2.9 to 2.2 times. This seems to be a bit of a knee-jerk reaction in our opinion, or, better put, an overestimation of the negative outlook. Essentially, the market is swinging in the extremes. What Prudential plc have proved to us, and it is a blueprint for any life insurance company, is the ability to enter an emerging, and underdeveloped life insurance market, and build a presence with quality products and services, including a good asset management offering. That is important because the majority of this is participating business. While it is true that one of Prudential’s high growth markets has been China, and indirectly Hong Kong from visiting mainland Chinese, we see Malaysia, Singapore, Thailand, and Taiwan all as substantially underdeveloped markets that show similar characteristics to China and Hong Kong that Prudential can exploit. Repeat sales in some of these markets are near or above 50%. These markets, in our opinion, provide a nice combination of affluent and aging as well as young and aspiring populations with decent life and health insurance gaps.