February 06, 2015 Prudential Financial Inc. Current Recommendation NEUTRAL Prior Recommendation Outperform Date of Last Change 04/03/2014 Current Price (02/05/15) $75.32 Target Price $79.00 SUMMARY DATA (PRU-NYSE) SUMMARY Prudential Financial Inc. s fourth-quarter earnings missed the Zacks Consensus Estimate and declined 23.9% on a year-over-year basis. Results suffered as higher expenses eclipsed revenue growth during the quarter. Lower contribution from Individual Annuities, weaker earnings from the Individual Life segment and Group Insurance resulted in the year-over-year decline. Despite the quarter s miss we cannot overlook the company s well-diversified business profile and extensive market reach, that position it well to benefit from a rise in aging Americans. It continues to payback shareholders riding on the strength of its capital position. Moreover, the acquisition of the Hartford Individual Life Insurance business has boosted Prudential s individual life insurance in the U.S. The company has been rated favorably by rating agencies. We, thus, maintain our Neutral recommendation on the stock. 52-Week High $93.16 52-Week Low $75.32 One-Year Return (%) -5.87 Beta 1.66 Average Daily Volume (sh) 3,030,276 Shares Outstanding (mil) 456 Market Capitalization ($mil) $34,346 Short Interest Ratio (days) 1.81 Institutional Ownership (%) 63 Insider Ownership (%) 1 Risk Level * Below Avg., Type of Stock Large-Value Industry Ins-Multi Line Zacks Industry Rank * 109 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) Annual Cash Dividend $2.32 Dividend Yield (%) 3.08 5-Yr. Historical Growth Rates Sales (%) 18.7 Earnings Per Share (%) 11.4 Dividend (%) 26.8 using TTM EPS 8.2 using 2015 Estimate 7.5 using 2016 Estimate 7.1 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page 2013 11,834 A 11,723 A 10,816 A 10,978 A 45,351 A 2014 10,936 A 11,113 A 11,766 A 15,829 A 49,644 A 2015 10,992 E 11,002 E 11,115 E 11,791 E 44,900 E 2016 45,618 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $2.28 A $2.30 A $2.94 A $2.20 A $9.72 A 2014 $2.40 A $2.49 A $2.20 A $2.12 A $9.21 A 2015 $2.43 E $2.48 E $2.51 E $2.56 E $9.98 E 2016 $10.60 E Projected EPS Growth - Next 5 Years % 10 2015Zacks Investment Research, All Rights reserved. www.zacks.com 111 North Canal Street, Chicago IL 60606
RECENT NEWS Prudential Q4 Earnings Miss on High Expenses, Revenues Up Feb 4, 2015 U.S. life insurer Prudential Financial Inc. reported fourth-quarter 2014 operating net earnings of $2.12 per share, missing the Zacks Consensus Estimate by 10.9% and declining 3.6% on a year-over-year basis. Results suffered as higher expenses eclipsed revenue growth during the quarter. Lower contribution from Individual Annuities, weaker earnings from the Individual Life segment and Group Insurance resulted in the year-over-year decline. Including one-time items, the company incurred loss of $2.69 per share in the quarter, wider than the $0.94 per share loss incurred in the year-ago quarter. Meanwhile, total revenue increased 44.2% year over year to $15.8 billion primarily on higher premium, higher policy charges and fee income, and net investment income. Reported revenues were also above the Zacks Consensus Estimate of $12.1 billion. Total benefits and expenses were $14.5 billion in the quarter, 52% higher year over year. The increase was due to higher insurance and annuity benefits, interest and other expenses. Full-Year Review Operating net earnings came in at $9.21 per share, missing the Zacks Consensus Estimate of $9.49. Prudential reported net income of $3.23 per share in 2014, rebounding from the year-ago loss of $1.55 per share. Revenues of $49.6 billion improved 9.6% over 2013. Quarterly Segment Update U.S. Retirement Solutions and Investment Management reported adjusted operating income of $823 million, down 17.4% year over year. The downside was due to lower contribution from Individual Annuities and Asset Management. Adjusted operating income at U.S. Individual Life and Group Insurance decreased a considerable 24.6% year over year to $162 million. The decline was due to lower contribution from the Individual Life segment and the Group Insurance segment. Adjusted operating income at International Insurance increased 6% year over year to $686 million led by improved performance at Life Planner. Corporate and Other Operations adjusted loss narrowed to $326 million from loss of $397 million recorded in the year-ago quarter due to lower expenses. Meanwhile, Prudential s assets under management increased 6.2% year over year to $1.176 trillion as of Dec 31, 2014. Financial Position Adjusted book value per share, which reflects a company s net worth, was $64.75 as of Dec 31, 2014, up 7.9% from the Dec 2013 level. Equity Research PRU Page 2
During the fourth quarter, Prudential bought back 2.9 million shares of its common stock for $250 million. It is left with $500 million under the authorization. VALUATION Prudential s shares currently trade at 7.5x our earnings estimate for 2015 which is at a 35.3% discount to the industry average. On a price-to-book basis, the shares trade at 0.8x, at 27.3% discount to the industry average. The valuation on a price-to-book basis looks attractive, given that the trailing 12-month ROE is ahead of the industry average. Our six-month target price of $79.00 equates to about 7.9x our earnings estimate for 2015. We view the $2.32 per common share annual dividend as secure, implying an expected total return of about 6.4% over that period. This is consistent with our Neutral recommendation on the shares. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Prudential Financial, Inc. (PRU)) 7.5 7.1 10.0 7.4 8.2 10.5 6.9 Industry Average 11.6 10.5 8.9 41.3 13.3 43.1 8.9 S&P 500 16.3 15.2 10.7 15.0 18.8 19.4 12.0 American International Group, Inc. (AIG) 10.4 9.2 10.6 6.6 10.7 23.6 7.2 MetLife, Inc. (MET) 8.3 7.7 6.8 8.0 8.5 12.5 5.8 AEGON N.V. (AEG) 9.0 7.2 NA 3.8 9.2 NA 4.6 Swiss Re Ltd (SSREY) 10.6 10.4 NA 4.0 7.6 8.3 5.5 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Prudential Financial, Inc. (PRU) 0.8 1.2 0.6 10.9 0.5 3.1-5.1 Industry Average 1.1 1.1 1.1 8.9 0.4 1.7 5.0 S&P 500 5.3 9.8 3.2 25.5 2.1 Equity Research PRU Page 3
Earnings Surprise and Estimate Revision History NOTE THIS IS A NEWS-ONLY UPDATE; THE REST OF THIS REPORT HAS NOT BEEN UPDATED YET. Equity Research PRU Page 4
OVERVIEW Headquartered in Newark, NJ, Prudential Financial Inc. was founded in 1875. Through its subsidiaries and affiliates, Prudential offers a wide array of financial products and services including life insurance, annuities, retirement-related services, mutual funds, investment management and real estate services. These products and services are offered to individual and institutional customers through one of the largest distribution networks in the financial services industry. Prudential has organized its principal operations into the Financial Services Business and the Closed Block Business. The Financial Services Business consists of three operating divisions, which together encompass six segments and the Corporate and Other operations. The U.S. Retirement Solutions and Investment Management division sells individual variable and fixed annuity products, apart from providing retirement investment and income products and services to retirement plan sponsors in the public, private and non-profit sectors. This division also provides investment management and advisory services to the public and private marketplace. The U.S. Individual Life and Group Insurance division provides individual variable life, term life, and universal life insurance products; group life, long-term and short-term group disability; longterm care; and group corporate-owned as well as trust-owned life insurance products to institutional clients. It also sells accidental death and dismemberment, and other ancillary coverage, and provides plan administrative services. The International Insurance and Investments division offers international individual life insurance products in Japan, Korea and other countries; and provides proprietary and nonproprietary asset management as well as investment advice and services to retail and institutional clients internationally. Closed Block Business consists of life insurance and annuity policies that were issued before the company went public in Dec 2001 but are still in force. Prudential s Class B Stock, which is not traded on any exchange, reflects the performance of its Closed Block Business. REASONS TO BUY Prudential is set to benefit from the aging American population. The company will witness huge demand for retirement benefits products for baby boomers. The U.S. Census Bureau projects that nearly 25% of the population will be 65 years or more by 2050. Prudential s vast distribution network, superior brand image and time-tested presence will give it a competitive edge vis-à-vis its peers. The acquisition of Individual Life Insurance business of The Hartford Financial Services Group in Jan 2013 through a reinsurance transaction carved out a long-term strategic growth path for Prudential. It will help Prudential earn a place among the top five individual life insurance companies in the U.S. in terms of new recurring premium sales while also providing greater scale, expanded product offerings and broader distribution capabilities. Prudential will command leading positions in universal, term and variable life insurance. The acquired business is delivering the expected product and distribution benefits. The acquisition helped the segment to achieve 77% year-over-year sales growth in 2013. Prudential s Retirement segment is set to benefit from the company s penetration in the pension risk transfer business. Factors such as a low interest rate, greater accounting and regulatory changes Equity Research PRU Page 5
and larger-than-expected funding contributions have increased the appetite for risk of pension plan sponsors. There has been a worldwide escalation in pension de-risking demand, with the U.K. emerging as the leading market. The company is striving to build its leadership position in a market which presents great potential and is an excellent fit for its skills in managing group annuity, in which it boasts a track record of more than 80 years. Prudential has a strong international presence that provides it with better organic growth opportunities than its peers. Expanding its international business (mainly in Japan, Korea and China) is a vital component of the company s long-term growth strategy. Prudential has a strong footprint in Japan, as it has been operating in the region for several years now. Japan offers attractive opportunities for Prudential to capitalize on its protection products and retirement needs. The acquisition of Star Edison closed in Feb 2011 has broadened the company s distribution and increased the scale of its operations and client base by roughly 50%. Management also expects that the acquisition will push the group s long-term ROE above 15% in 2015. Prudential is also penetrating China which offers huge potential. The company s business in Brazil has gained sufficient scale and should become an important contributor to earnings growth in the international division over the next few years. In Jan 2014, the company acquired Uni.Asia Life Assurance Berhad (UAL), a mid-sized life insurer in Malaysia which is an attractive market, with low life insurance penetration, a well-developed regulatory environment and long-term growth potential. Prudential has been successfully generating shareholders value by resorting to shareholder-friendly measures, such as dividend payments and share repurchases. The company also maintains active capital management through share buyback. Maintaining robust capital and liquidity positions shield the company from market volatility and enables it to retain the financial strength and flexibility needed to pursue new opportunities, consistent with its long-term strategy. REASONS TO SELL We maintain a cautious near-term outlook for Prudential s U.S. Group insurance business as poor disability margins pressure results. Though the company has started increasing the rates in the disability block, recovery is expected to be quite slow. In the Group Insurance business, we expect near-term results to be weighed down by high unemployment, limited wage inflation and intense competition. The segment s sales declined 29% year over year in 2013. Prudential s exposure to products like annuities and universal life, which guarantee minimum return, will keep its capital under strain. Its results have been suffering due to additional reserve accretion required when the low interest rate increases the value of these liabilities. We expect the trend to continue till a complete reversal of the interest rate scenario takes place. As interest rates in the U.S. continue to remain lower than historical levels, current reinvestment yields are consequently lower than the overall portfolio income yield, primarily for investments in fixed maturity securities and commercial mortgage loans. With the Federal Reserve Board s intention to keep interest rates low through at least 2014, overall portfolio income yields are expected to continue to decline throughout the coming year, which will in turn keep net investment income under pressure. Prudential has been deemed a systematically important financial institution (SIFI) by the Financial Stability Oversight Council. As such, the capital requirements for insurance SIFIs will be based on an insurance capital framework. Stricter capital standards might compel management to slow the pace of capital deployment such as share repurchases, which may weigh on the bottom line. Equity Research PRU Page 6
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of PRU. The EPS and revenue forecasts are the Zacks Consensus The analysts contributing to this report do not hold any shares of PRU. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1120 companies covered: Outperform - 15.5%, Neutral - 76.9%, Underperform 6.9%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research PRU Page 7