Demerging M&G is a positive for Pru, but things could go wrong, and worries elsewhere also hamper enthusiasm for the shares. However, some believe this is an opportunity. Lee Wild reports.
UK-listed insurers fell much faster than the wider market during October's sell-off, but are outperforming as equity markets bounce back. Yet, sector heavyweight Prudential remains grossly undervalued, according to some, and there’s scope for a big re-rating through 2019.
Less than 10 days ahead of a hotly-anticipated investor day, UBS analyst Colm Kelly points out that Prudential shares trade at a 30% discount to his sum-of-the-parts valuation. This, he believes, should narrow, as management executes on the proposed M&G Prudential demerger and delivers double-digit growth in Asia.
"The upcoming investor day (14 November) provides an opportunity to reassure on issues that we believe have dragged on share performance year-to-date, namely emerging market uncertainties, UK demerger execution risks and US capital concerns," writes Kelly in a 48-page 'buy' note.
"But it is catalysts through 2019 that can drive a stock re-rating, with the current 10.5x 2019E valuation providing an attractive entry point, in our view."
Down 12% since late September, the share price valuation looks modest, and drops to single-digits on forecasts for 2019.
Source: interactive investor (*) Past performance is not a guide to future performance
UBS reckon the shares are worth 2,100p, implying 31% potential upside. Kelly values the Asia business at 16 times 2019 earnings expectations, similar to rival AIA Group. Both its asset management business and US division are priced similar to peers, while the UK is valued at 1.1 times book value and a forward price/earnings (PE) ratio of 12.
Even at the target price, Pru shares are valued at just 12.7 times forward earnings and 2.9 times tangible net asset value.
"The market appears to be applying a significant discount to the UK valuation of Prudential owning to the execution risk and uncertainties of the proposed UK demerger," reckons Kelly. His sums put the implied discount versus UK peers at about 50%, much of which will be down to concerns about M&G.
While the investor day will likely focus more on the Asia and US businesses, it's hoped there'll be further clarity on M&G. Pru specified a two-year process when the UK demerger was announced in March, but UBS thinks it could reach a conclusion during the second half of 2019.
"We think valuation discount outweighs the risks at this point and believe that reducing execution risk through 2019 can act as a positive catalyst for the share price," says Kelly.
In Asia, Pru trades at a discount to AIA, but is already shifting focus toward higher margin health and protection business – up 20% from Q1 to Q2 2018. After growing Asia profit by 11% year-on-year in the first half, this should increase confidence in Prudential's ability to deliver double-digit profit growth sustainably in future.
*Horizontal lines on charts represent levels of previous technical support and resistance. Red line represents uptrend since March 2009.
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