Before this week’s tip, I want to mention my concerns over the recent equity rally. Sentiment has improved since Bear Stearns was bought by JP Morgan, but I suspect this is another “dead cat bounce” partly triggered by speculators covering short positions. The bulls point to the fact that US consumers will get about $110bn in tax rebates as of May, around $950 per household. Yet this is dwarfed by damage from the housing market, rising energy and unemployment costs. The IMF expects unemployment in the US to leap from 5.1% now to 6.3% by the end of 2009. Investors should tread carefully.
Legal & General (LGEN), rated a BUY by Collins Stewart
In that light, one stock to tuck away for the long term is Legal & General (L&G), the UK’s third-largest insurer and a leading life, pensions and investment manager. Legal & General has proved resilient, falling just 3% since the start of the year, against 6% for the FTSE 100. What’s behind this outperformance?
Legal & General is cheap, trading at a slight discount to its net asset (or European Embedded) value of 134p per share, and paying a 4.5% dividend yield. Its balance sheet is robust too; Standard & Poor’s and Moody’s assess its financial strength as “very strong” or “excellent”. As at December, the firm had “no material exposure” to credit-impaired securities, although it’s just begun to buy collateralised debt obligations (CDOs) to take advantage of distressed sellers.
Next, Legal & General should benefit from the trend for firms to transfer pension schemes to specialists, who have economies of scale and more sophisticated risk-management systems. In the first quarter, L&G quadrupled bulk annuity sales from £17m to £72m, helped by a £180m deal with M-real (a paper supplier) to take on its UK defined-benefit pension scheme covering 2,000 members. CEO Tim Breedon expects the market to stay strong. On Monday, The Daily Telegraph reported that Smiths had just agreed to pass £250m of pension assets to Legal & General.
Of course, there are possible pitfalls. For instance, Legal & General offers mortgage protection (eg, salary and critical illness) products, together with life-assurance policies that depend on future mortality rates. So a prolonged housing-market downturn, or higher-than-expected growth in life expectancy would hit earnings. The group also provides fund-management services covering £297bn in assets, so significant falls in the value of these investments would directly affect fee income.
Also, sales of unit-linked bonds fell by 46% to £40m in the first quarter due to changes in capital gains tax that have made collective investment products (such as unit trusts) more attractive than insurance-based schemes. Legal & General is also subject to regulatory risk, while its non-life insurance products carry uncertainty as to the ultimate cost of claims.
All the same, Legal & General delivered respectable first-quarter results, with the City expecting 2008 earnings per share of 13.4p, rising to 14.9p in 2009. And although share-price volatility may rise once the company’s £1bn buyback programme has ended (about £407m left), I believe the stock is good value for the patient investor. The next trading update is due on 14 May.
Recommendation: LONG-TERM BUY at 126p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments