Interactive Investor

Stockwatch: this 9.5% yielding FTSE 100 share is a buy

With one of the most generous dividends around and trading on a modest valuation, analyst Edmond Jackson thinks this blue-chip share is in buying range.

5th April 2024 11:21

by Edmond Jackson from interactive investor

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Does a 10% drop in the FTSE 100-listed shares of investment manager M&G Ordinary Shares (LSE:MNG) merit buying into?

Going ex-dividend on a substantial yield of near 10%, M&G shares fell a similar proportion to 212p even before yesterday’s US market drop, which has taken it now to 207p.

It begs the tactical question: should you trade around ex-dividend dates, with the possibility of scalping gains and even managing capital gains tax liabilities better, at the cost of complicating your tax return if the shares are not held in a self-invested personal pension (SIPP) or ISA?

Yet a circa £620 million drop in market value compares with a 19.7p per share total dividend costing £467 million. Moreover, payouts are split between a 6.5p interim last November, and 13.2p due 9 May.

There has not been comparable weakness, for example, in the share prices of Liontrust Asset Management (LSE:LIO) or Jupiter Fund Management (LSE:JUP) just lately. Yet M&G nowadays is a different beast, not mainly a seller of unit trusts, since the UK operations of Prudential (LSE:PRU) were de-merged and integrated with it.

Yes, general confidence in financial markets is significantly why valuations of insurance-type companies – most especially life/health – tend to move with the values of the substantial bond/equity portfolios they run, to meet long-term liabilities. We see this, for example, in Aviva (LSE:AV.). and Legal & General Group (LSE:LGEN) also.

But when a dividend stretches even to high single-digit per cent, either something is profoundly wrong with the company, or the shares are ultimately going to “mean-revert” higher because the yield is priced too generously for the risk involved. In which case, investors who buy on weakness achieve a double whammy of locking in a fat yield and then ride capital gains.

Around 2,350p, British American Tobacco (LSE:BATS), for example, sports a yield expected to be just over 10%, but tobacco seems in global decline and vaping is not yet sufficiently profitable, while a regulatory backlash is under way. You would think asset management and life/health insurance is significantly less risky.

The 2023 annual accounts imply dividend stability

The consolidated income statement on page 184 initially displays an “insurance service result” by way of £3,887 million revenue offset by £2,834 million expenses. This sub-£1 billion outcome is marginalised by £6,214 million investment return and a net £2,418 million from other financial asset exposure. Selling unit trusts is seemingly dwarfed for presentation at the group accounting level.

The net insurance/investment result is £2,313 million, with another £1,003 million fee income added but, unfortunately, £2,241 million of administrative expenses and various charges whittle the net profit outcome down to £309 million. That at least is much better than a £2,055 million loss, restated for 2022, but seemingly does not cover dividend payouts expected to rise to over 20p.

Yet dividends are paid out of cash, not profit. The cash flow statement on page 189 shows £2,016 million generated from operations, turned around from £504 million absorbed. Investment took £603 million (an insurer does not have to invest materially, beyond ensuring it is price-competitive) just £189 million interest the dividend took a modest £462 million. Period-end cash rose by £708 million to £5,590 million.

Some of that cash chest may be required to doubly insure that M&G can meet long-term liabilities in the event, say, of a massive financial crisis. But if management has its act together, the financial statements imply good odds of dividend growth.

Six-year financial context looks broadly supportive

The table shows M&G had a difficult 2018 and 2022, yet it has managed to sustain dividend growth from 2019 despite some erratic earnings cover. Admittedly, and despite a strong 2023 cash flow statement, the free cash flow record does vary.

Returns on capital employed are poor, despite the operating margin having some very good years. It is similarly poor for Sainsbury (J) (LSE:SBRY), however, despite this food retailer being regarded as delivering a reliable circa 5% yield.

M&G -financial summary
Year-end 31 Dec

Turnover (£ million)-4,62730,68214,03614,7397865,115
Operating margin (%)-21.311.925.04.5-46616.4
Operating profit (£m)9853,6573,516656-3,665838
Net profit (£m)33.01,1201,13883.0-2,068297
Reported EPS (p)31.140.844.03.2-83.612.4
Normalised EPS (p)43.850.156.512.6-73.120.4
Return on total capital (%)
Operating cashflow/share (p)54.17.999.650.8-20.484.1
Capex/share (p)9.315.131.729.923.220.7
Free cashflow/share (p)44.8-7.267.920.9-43.563.4
Dividend per share (p)0.011.918.218.319.619.7
Covered by earnings (x)
Cash (£m)6,3735,8486,5186,9084,2984,998
Net debt (£m)-1,9762,0072,0962,4353,6143,387
Net assets/share (p)344197215278182171

Source: company accounts.

Consensus is for M&G to deliver a circa 3% annual rise, to 20.3p in respect of this year and 20.9p for 2025.

Other life/health type insurers do quite similarly offer big yields: Legal & General is expected for 8.5% with its shares currently around 250p and Aviva 7.2% at 490p, despite a rally from 375p last September. There is a case possibly to diversify or, if you already hold one or both, compare and consider M&G at 207p.

By contrast, Prudential is the standout under-performer, stuck in a persistent bear market from 1,340p in January 2023 to below 720p today, albeit with only a 2.5% yield projected.

In terms of forward price/earnings (PE) ratio, Aviva leads on 11x, Legal & General just below 10x, and M&G and Prudential on 8x – which goes to show the order in which they are regarded. M&G’s yield implies to me, at least, it should trade nearer Aviva/Legal’s ratings.

Management on track for £2.5 billion operating cash flow

Such was the narrative with the 21 March annual results, asserting “positive business momentum and meaningful improvements across key financial metrics...underscoring our balanced and diversified business model, with strong growth despite macroeconomic uncertainty”.

At least in the narrative, asset management is cited as delivering £0.8 billion net client inflows despite the wider market suffering redemptions.

The group is in the first year of a transformation programme to create a leaner more efficient organisation, with £73 million of cost savings offsetting inflationary pressures. Most asset managers are undertaking similar though.

Crucially again for the dividend, management says its actions on efficiency support its £2.5 billion operating cash generation target “by end 2024”, which sounds like what they promise to achieve rather than some “annualised rate going forward”.

Wild card is always what financial markets may do

If you think a disconnect has become established – expectations of interest rate cuts being too far ahead of reality, and that at best we might just see a modest cut later this year – then possibly further downside lies ahead for equities, especially in the US.

It’s unclear quite whether M&G would deserve to be part of that when its yield is already so high, but changes in market values would be judged to be affecting its investment carrying values.

A median view would be that markets are overdue a correction anyway after strong runs from last autumn. Just do not expect to get much luckier when you are already offered a yield as high and well supported as M&G’s.

I therefore conclude at least to consider averaging in. Buy.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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