Shares in Prudential (LSE: PRU) reached an all-time high today, as investors digested the significance of the company’s strong financial performance in 2016. And although the shares have enjoyed a strong run over recent months, the Asia-focused life insurer still looks good value, as the group is well positioned for further growth.
Further growth potential
Prudential posted record operating profits this week, with full-year pre-tax profits up 7% to £4.3bn. As expected, Asia is the company’s main growth engine. Operating profits there continues to grow at a fast clip, as IFRS profits from Asia gained 28% to £1.6bn last year, thanks to robust new business growth and the weak pound.
These latest results validate the company’s pivot towards Asia. Its delivery of year-on-year double-digit growth in Asia provides evidence of its sound strategy and growth plan. Prudential now earns 35% of its profits there, with the region accounting for more than half of its new business sales.
There’s also further growth potential from Asia’s growing middle class, who are investing more money in life insurance products to secure a comfortable retirement. Insurance penetration remains relatively low in Asia and there is considerable scope for catch-up growth.
Despite the attractive growth outlook, shares in Prudential only trade in line with its slower-growing UK and European peers, with a forward P/E ratio of 12.1 and price-to-embedded value of 1.16x. By contrast, its Asian life insurance peers trade at around 1.8 times embedded value, with an average forward P/E ratio of just over 17.
This makes Prudential shares seems seriously undervalued, as the insurer has consistently generated outsized long-term growth, profitability and cash flow than many of its peers — Prudential’s valuation should take into account of its consistently strong track record.
The market capitalisation for the insurer could potentially be worth £8bn more if its valuation multiples were to converge with its faster growing Asian peers to better reflect its geographical and product mix. That would give us a potential upside of nearly 18%, and value its shares at 2,070p.
And I’m not the only one optimistic on the company. Prudential is favoured by many sell-side analysts — out of the 17 recommendations, 11 are ‘strong buys’, one is a ‘buy’, four are ‘holds’ and only one is a ‘strong sell’. Additionally, City brokers UBS and Morgan Stanley reiterated their ‘buy’ ratings in recent days, and have raised their price targets for Pru’s shares to 2,000p and 2,095p, respectively.
Many analysts also expect Prudential is well-placed to return more cash to shareholders as it is generating robust cash flows and has a strong capital position. The group has already announced a 12% increase in its dividend this week, but more could yet be to come, as its Solvency II coverage ratio improved to 201% — up from 193% last year.
Investing in the Pru is not without its risks though. The group’s recent growth is unbalanced, with the performance of its UK and asset management arm M&G continuing to drag on earnings. There are also growing concerns that a clampdown on capital outflows by Chinese regulators could hurt sales this year.
But, looking forward, I expect any slowdown to be mild and temporary and continue to expect the company to deliver steady earnings and dividend growth over the next few years.