Shares of Legal & General Group PLC (LSE:LGEN, Financial) have been trading sideways for the last nine months. Additionally, for the past two years, the stock has traded below its GF Value indication.
Despite the unexciting stock price, Legal & General Group, known as L&G, has generated decent returns thanks to its strong dividend. During the brief Covid-19 crisis market crash in March last year, the dividend yield rose to nearly 13%. Before the pandemic, the dividend yield was often above 6%. Investors deem the life insurance business to be boring.
I am happy to own a boring stock as part of a diversified portfolio. It’s a hedge against the riskier investments and reduces overall portfolio volatility.
L&G’s first-half results, which were released in early August, beat consensus expectations and saw operating profit grow by 14%. Cash generation also grew 14% and the interim dividend was raised by 5%. Not bad for a boring stock.
The progressive dividend policy was understandably halted last year as global uncertainty rose with the pandemic. Insurance is all about asset liability management and managing financial risk, so I thought that temporarily holding the dividend steady was a prudent move. But the short-term oriented Mr. Market didn’t like this decision. Longer term, L&G is aiming to raise the dividend by between 3% and 6% each year through to 2024. This year’s total dividend is likely to be just slightly above 18 pence (25 cents) a share, compared to 2020’s 17.6 pence. L&G has grown the dividend steadily since 2009. The current dividend yield is 6.6%, which is higher than most insurance companies.
Legal & General Group is a holding company and a member of the FTSE 100. Through its subsidiaries, the company operates as an asset manager and a provider of individual life insurance products. Its segments consist of Legal & General Retirement, which include annuity contracts, longevity insurance contracts, lifetime mortgages and Lifetime Care Plan; Legal & General Investment Management, which includes one of the U.K.’s leading index fund management franchises, active strategies, solutions and liability-driven investment, multiasset funds, real assets and workplace savings; Legal & General Capital, which includes investment strategy and implementation and direct investments and structuring; Legal & General Insurance; and General Insurance.
Several of these business units look well placed to produce even more cash. For instance, the pension risk transfer market opportunity is large. Defined-benefit pension schemes pay insurers to take on some or all of the obligation to pay retirement income to their members.
Obviously, for an insurer, the pandemic has caused a little short-term pain, but the pension risk transfer business continued to be the biggest profit generator for L&G during the first half of the year. For 2021, the core U.K. market should trade in line with 2020, CEO Nigel Wilson said, but that would still be below the 2019 level. Trading in the less mature U.S. market is expected to see growth compared to last year.
Moving past the pandemic, in the long term, L&G thinks it can get a larger slice of the pie. Only 12% of U.K. defined-benefit pension liabilities have been moved over to insurance companies. The company could potentially write 50 billion pounds worth of new U.K. business over the next five years and given the rate of new business it was generating before the pandemic, this is a real possibility, not just management over-optimism. Additionally, there is a lot of business development synergy with from clients of its asset management business.
Some analysts and commentators have speculated that L&G’s pension risk transfer business could be a drain on capital as L&G takes on the risk of pension liabilities. However, the company's management has a plan to asset liability match these risks within five years. This would essentially derisk the business and funding dividend growth would be easier.
L&G’s solvency II ratio stood at a healthy 183% at the end of June. These are European rules governing how insurers are funded and governed. Given many of the company's liabilities are fixed in nominal terms, and much of its assets are equity-like, inflation would be beneficial for the solvency II ratio and would free up cash to return to shareholders.
Another attractive feature of L&G is its chairman, the highly respected Sir John Kingman, who has had a distinguished career in both the U.K.’s Treasury (having been closely involved in the U.K. government’s response to the financial crisis) and the City of London as a financier more generally. He is someone I believe to truly understand financial risk. In 2018, he undertook a highly critical independent review for the U.K. government of the Financial Reporting Council.
This, along with L&G’s undemanding valuation, potential upside if the business derisks as planned and with earnings forecast to cover the next dividend by about 1.7 times, means L&G’s boring status makes me excited to hold it as part of my portfolio, for stability and hopefully strong total shareholder returns in its own right.
