Legal & General (LSE: LGEN), rated OUTPERFORM by Barclays Capital
With UK interest rates set to remain at 0.5% for the foreseeable future, and the Bank of England splashing out another £75bn on quantitative easing (QE), we can forget worrying about deflation. In fact, government yield curves are currently implying negative real cash returns until early 2016. That’s bad news for bondholders. I’d rather trust in stocks to protect my portfolio against inflation, particularly those with sound balance sheets and attractive dividend yields. UK life assurer and fund manager L&G is one such play.
It has a stout capital surplus of £4bn – 238% above regulatory requirements – and has a mere 1.4% exposure to dodgy eurozone debt. Performance is ticking along nicely too. In the first half, new business rose by 4% to £920m on an annual premium equivalent basis. The savings division was the star of the show. Here profits leapt by 25% to £68m buoyed by strong demand for individual savings accounts (Isas), unit trusts and self-invested personal pensions (Sipps).
There was also a nifty bit of footwork from the investment management unit, where operating profits were 19% higher at £117m, supported by £3bn of net new mandates. That pushed up funds under management from £320bn to £362bn.
All told, the net asset value (NAV) closed June at 139p, up 17%. Net cash generation rose 14% to £427m, prompting a 25% jump in the dividend. Chief executive Tim Breedon also suggested that this could rise further once the uncertainty created by the forthcoming European capital regime known as Solvency II had been settled. The City expects 2011 revenues, adjusted EPS and dividends of £5.4bn, 13.0p and 5.8p respectively, putting the shares on a p/e ratio of 7.7, and paying a juicy 5.5% yield. I rate L&G on a 0.9 times NAV multiple, or around 125p a share.
There are risks. Accounting for life-assurers is a notoriously dark art. If there’s another European crisis, L&G may end up with some wounds to lick. Also, L&G offers protection products (such as critical illness insurance) that are typically bought when properties are purchased, as well as life assurance policies that depend on future mortality rates. As such, earnings could be impacted if there is another fall in the housing market or life expectancies increase by more than current projections.
But with leading positions in most of its markets, together with benefiting from the ongoing trends of ageing populations, increased saving ratios, a smaller welfare state and the need for greater personal pension provision, then L&G ticks all the right boxes. Barclays Capital has a price target of 147p. Third-quarter results are scheduled for 9 November.
Rating: BUY at 102p
• Paul Hill also writes the Precision Guided Investments newsletter. Call 020-7633 3634 or see www.moneyweek.com/PGI.