Legal & General: Our Edge Is Still Here, Confirmed Buy (OTCMKTS:LGGNF)

Following Legal & General Group Plc’s (OTCPK:LGGNF)(OTCPK:LGGNY) Capital Markets Day launched in mid-June, we return today to comment on H1 results. As a reminder, UK companies typically report their financial results twice a year, following a practice known as interim reporting. Inter and bottom line results are crucial to stakeholders as they provide insight into the company’s financial health and operational performance. For this reason, it is essential to report the most recent earnings. Since our last update (Fig 1) and considering Monday’s global sale due to fears of a US recession, the company’s share price remained flat.

Our buy rating is supported by 1) L&G plans to divest non-strategic assets, 2) unification of asset management divisions to optimize underlying operating expenses, 3) capitalizing on institutional retirement opportunity, 4) priorities to support capital allocation with buybacks . , and a progressive dividend policy and, more importantly, and 5) year Attractive ROE that will lead to appreciation over time.

Fig 1

Income results S1

Here at the lab, we believe that L&G has delivered solid results. Compared to last year, the underlying operating performance remains stable. In numbers, L&G reported EBIT of £849m against a result of £844m achieved in H1 2023 (Fig 2). This is not surprising given L&G’s comment during Capital Markets Day in June. There is also an expectation of mid-single digit EBIT growth for all of 2024. Looking at Wall Street expectations, the company reported a 2% decline. Therefore, we could expect a positive share price reaction in the future. Looking at the report, the company reported a profit after tax of £223m. This was due to large negative investment variances of minus £417 million, driven by the mark-to-market impact on annuities business, following movements in inflation and rising interest rates. In addition, we also report a lower profit of -£187m due to non-core business. This was due to a negative write-off in L&G’s wage finance division. Excluding this extraordinary impact, the company’s operating profit per share increased by 3.1%, with an ROE of 35.4%.

Operating surplus generation was also 6% ahead of consensus, with net capital generation of £731m. On a positive note, L&G’s Solvency II ratio reached 223%. This demonstrates financial support in the event of market turbulence.

Source: Presentation of L&G H1 results – Fig 2

After the CMD, there was no change in the short- and medium-term financial orientation (Fig 3).

Fig 3

Why are we still positive?

There are three areas where we still believe there is an advantage.

1. (Greater efficiency). Management actions are important for L&G, and the company is set to achieve lower operating expenses by combining the Legal & General Investment Management and Legal & General Capital divisions. A unique workforce in the creation and distribution of private and public market solutions will also support this potential outcome. That said, the company reported integrating cost optimization such as IT platform and procurement savings (Fig 5). Here at the lab, we think L&G can generate £250m a year in synergies, compared to a consensus expectation of £200m. This saving could also be reinvested in the business;
2. (Rising remuneration and divestment). A near-term catalyst is the potential divestment of builder L&G CALA Homes. L&G wants at least >£1bn for the asset. We view this potential transaction as positive and could free up capital to distribute to shareholders with a buyback. However, according to our estimates, if this were to be followed by a share buyback, it could lead to a lower solvency ratio. On a standalone basis, we still see an upside from the current return on capital. This cannot go unnoticed. In 2024, the company has increased its DPS by 5% and there is also a £200 million buyback. In addition, we already have visibility of 2% DPS growth per year until 2027. According to the company note (Fig 6), there is also potential for “other similar redemptions.” At the current market price, L&G has a yield of nearly 9.79%. L&G goes ex-dividend on 22/08/2024, so this is a good time to increase or start a position;
3. (An advantage in growing L&G’s core business) On the business side, institutional retirement EBIT increased by 6% due to the consistent investment performance of L&G’s annuity portfolio (fig. 4), which underscores solid earnings progression. In addition, UK Pensions Risk Transfer reported an increase of £1.5 billion. Even though this result was lower than last year, we are positively reporting a reserve of £5 billion in potential new contracts. In addition, new business Contractual Service Margin reached £14.5bn with £303m in new business contributions. Linked to the Asset Management platform, the company invests £50-100m per annum and is conditional on generating net inflows in private asset flows and real AUM. Otherwise, the company has the option to reduce or reduce this investment. This could improve the cost-income ratio. In this scenario, we believe L&G will be able to exceed its EBIT profit target of £500/£600m.

Fig 4

Fig 5

Fig 6

No change in estimates and assessment

Our internal model did not change post-H1 results. Following our CMD adjustment, we forecast core operating profit and EPS of £1.86 billion 29 cents for 2024. This takes into account the lower results of the AUM division and support from the Institutional Retirement Solutions segment, which aligned with the number released by S1. We like the company’s new growth strategy, with a clearer focus on segment areas where it has a “the right to win.“Compared to the street, we also price for better synergies due to business overlaps.

In terms of valuation, it is vital to report how the sector is trading. Looking at the MSCI Europe Insurance index, the forward P/E multiple is set at 10.3x (Fig 7). This is also aligned with the SA assessment data (Fig 8). We also note that the EU insurance sector is valued in line with historical levels. A forward 12-month dividend yield should also be considered. L&G has a yield of 9.79%, compared to a five-year average of 8%. L&G’s valuation screen is very compelling and we believe there is a continued mismatch. This is a growing company with better operating performance on a cost basis. Valuing L&G at an unchanged sector median P/E of 10x, we reiterated our valuation of £2.9 per share.

Fig 7

Fig 8

risks

Here in the lab, we report our previous risk section (Fig 9). Additionally, there are several different metrics that we include to consider that could impact L&G. In detail, lower interest rates are bad for the company; this reduces investment income and could affect shareholder remuneration. Lower rates could help reduce credit risk; however, this is decremental to operating results, lowering the solvency ratio. We also report execution risks through the combination of the Legal & General Investment Management and Legal & General Capital divisions.

The company is also undergoing divestment activities. Any transaction can be incremental as well as decremental to shareholder value.

Fig 9

Conclusion

We see the positive H1 results. The company is investing for growth while optimizing its operating expenses. Given the small bear in operating profit and surplus capital generation, we expect a positive share price reaction. Given the valuation gap to peers, we confirm our Buy rating estimates.

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