Barron’s published an article this weekend on U.K.-based insurer Phoenix Group Holdings PLC (PHXXF, Financial)(LSE:PHNX, Financial). Phoenix services annuities that were sold by other insurance companies. The stock has an awesome dividend, but we’re afraid its huge portfolio of equities and fixed income will affect that payout.
The stock trades for 7.04 pounds ($9.19), there are 720.21 million shares and the market cap is 5 billion pounds ($6.7 billion). Not a small company. Earnings were 67 pence and the stock trades at a price-earnings ratio of 10.5. The dividend is 47 pence and the dividend yield is 6.7%. Extremely cheap based on these two metrics.
According to the Barron’s article, RBC has a target price of 8.04 pounds. The ratings firm thinks Phoenix’s investment portfolio will allow it to keep paying the dividend for a long time. The company was added to the FTSE 100 and the stock is up since the article was printed last weekend. Phoenix bought part of Standard Life Aberdeen’s (LSE:SLA, Financial) business, so the synergies are expected to flow to the bottom line. I assume that will come through some layoffs.
Phoenix controls 10 million policies and 226 billion pounds in assets. The company operates under the Phoenix, Sunlife and Standard Life names. Approximately 25% of the company’s assets are classified as with profit. These are endowments, whole of life, pension products and guaranteed annuity options. About 65% are unit-linked, which I take to be variable annuities and variable life policies. Around 9% are non-profit annuities, which are cash streams paid out to retirees. The remaining 1% is whole life policies.
To further break down assets, it has 118 billion pounds in what the company calls U.K. Heritage. This is various annuities and life insurance products from over 100 companies. These companies no long want to service these products, so have sold them to Phoenix. When Standard Life sold Phoenix part of its business, it took a 20% share in Phoenix. Phoenix sells new business under the Standard Life name.
No doubt, the company has been making money and passing it on to shareholders. My question is what happens if the financial markets fall? If the company services a $100,000 variable annuity and the value is $50,000 after the markets fall, then doesn’t its revenue stream get cut in half?
I decided to pull up some of the literature that describes Phoenix’s products. Sure enough, they are very similar to American variable annuities. The fees on the funds range from 0.2% to 1.2%. Looking at one of its funds, the Standard Life MyPortoflio Managed Income Fund, the fees are 1.375%. Yikes! Doesn’t sound cheap to me. That’s another issue. Can’t you do much of this with Vanguard funds? It seems to me that cheap index funds could pose big competition.
The way the assets and liabilities show on Phoenix’s balance sheet works like this. A $100,000 annuity shows as an asset and a liability. If that annuity rises or fall, that $100,000 changes.
Management put out a report showing various impacts upon the company’s cash generation. Management expects to produce 3.8 billion pounds in cash generation from 2019 to 2023. A 20% fall in equity markets is expected to have no effect. A 60% rise in interest rates will add 100 million pounds and a 60% fall will cost the same amount. Management has indeed hedged some of this risk, but what if the changes are larger than these?
Of the company’s 92 billion pounds in fixed income, 24 billion pounds is BBB or below. If you believe the forecasts by Jeff Gundlach and others, there may be some downgrades and defaults in BBB and below. I’ve looked at a lot of these companies' balance sheets and they carry a lot of debt.
Another risk is “run off.” As retirees take their money out or die, Phoenix has fewer assets. They must buy more companies or hope the financial markets keep gaining.
So if you are a bull and think the financial markets will continue to rise, Phoenix might not be a bad bet with that huge dividend. If you are concerned about financial markets, Phoenix is too large to hide, even with part of its portfolio hedged. We’re not going to buy, but did think it was worth a look.
Disclosure: We do not own stock.
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