Legal & General's growth prospects

The Western financial sector features mature businesses with modest growth prospects. This is certainly the case for the banking and general insurance sectors. However, Legal & General (L&G) offers exposure to 5 long-term macro trends which include ageing demographics and ongoing welfare reforms.

Legal & General (L&G) is a UK focused assurance and savings group that is increasingly moving into global markets. In the first half of 2015 the company saw asset and premium growth in all of its five business divisions.

The business has been supported by five long-term macro trends which are 1) ageing populations, 2) welfare reform, 3) globalisation of asset markets, 4) digital lifestyles and 5) retrenching banks.

Legal & General’s business growth in H1 2015-09-25

Source – Legal & General investor presentation

1. Ageing demographics

The corporate sector is keen to de-risk the legacy of defined pension benefit schemes as members live longer. There are around US$10 trillion of these schemes globally and £1.8 trillion resides in the UK.

In the UK L&G is a leader in Liability Driven Investment Solutions (LDI) with around 40% of the market. The company states that the “opportunity remains significant” in this market to deliver attractive returns.

The Investment Management division and the Retirement business both benefit from the de-risking trend. Longer life-spans are also increasing demand for pension savings and retirement products.

Legal & General business growth

Source – Legal & General investor presentation

2. Welfare reform

The recently elected UK Conservative government is focused on reducing the welfare bill. This generates increased demand for protection products while pension reforms have also created an opportunity.

UK auto-enrolment in pensions has seen around 90% of members staying enrolled in a pension scheme. Defined contribution savings into pensions are therefore expected to triple over the next three years.   

Legal & General has been successful in this market with it providing pension schemes to 30 of the largest high street retailers. The group’s small and medium sized enterprise customers increased by 25% in the first half of 2015.

3. Globalisation of asset markets

Legal & General’s Investment Management division is benefiting from the globalisation of asset markets. From 2012 to 2014 its assets have increased from £543bn to £694bn and reached £715bn at mid-2015.

In the first half of 2015 the group won its first multi-billion US index mandate and saw momentum in Asia. International assets under management in the first half of 2015 increased by 67% on the first half of 2014 to £115.8bn.

4. Digital lifestyles

The focus on digital lifestyles helps Legal & General benefit from the shift towards managing investments on digital platforms. The group has a platform in place for SME’s and is launching a direct to consumer platform later this year.

5. Bank Retrenchment

Increased regulation and capital requirements have caused the banking sector to retreat from certain areas of the market. L&G is able to fill this gap, in areas like real estate, due to the long-dated profile of its annuity fund.

Direct investments increased by 35% in H1 2015 to £6.2bn with investments made in areas such as housing, alternative finance and urban regeneration. The company has a target of taking direct investments to over £15bn by 2019.

Targets from 2015 to 2019

These five macro trends will continue to benefit the business in the medium to long-term. As such L&G expects to double the size of its Investment management assets from 2015 to 2019.

The group also expects UK gross written insurance premium to grow at twice the rate of UK GDP. A new business segment is also set to be created in housing and urban regeneration.  

L&G’s plan for continued growth    

Source – Legal & General investment management

Growing profits and improving returns

From 2015 to 2019 the company expects to reduce its operating costs in nominal terms. This means that the company should be producing profitable growth rather than sales driven growth.

In 2012 the L&G’s return on equity was 15.4% while in the first half of 2015 it had increased to 19.1%. Adjusted earnings per share in the first half of 2015 increased by 15% to 9.79p and the dividend jumped 19% to 3.45p.

In terms of divisional profit generation and in the first half of 2015 the Retirement division (annuities) saw 49% operating profit growth to £280m. Insurance saw 7% operating profits growth to £192m.

Investment management has become increasingly important and saw 18% operating profits growth to £176m. L&G Capital, which has moved towards direct investments, was only founded in 2013 and saw 13% profits growth to £115m.

The balance sheet has remained strong with the IGD coverage ratio at a healthy 198% at June 2015. IGD measures the regulatory capital employed less the regulatory capital requirement.

Summary and valuation

Legal & General saw asset and premium momentum in its five business areas in the first half of 2015. There was also growth from 2012 to 2014 in investment management assets, insurance premiums, retirement assets and saving assets.

The five macro trends have provided support and are clearly going to continue for some time. Savings/pension growth in the UK is a strong opportunity along with the expansion of the Investment Management division on a global basis.

L&G has a number of ambitious business targets that it is pursuing from 2015 to 2019. These include doubling the investment management assets which if achieved will diversify the group and improve the quality of earnings.

Taking last Thursday’s closing share price of 239p (24 September, 2015) and the forecast P/E rating for 2015 is 12.4X, 11.5X in 2016 and then only 10.7X in 2017. This appears inexpensive given the historical performance and prospects for continued growth.

The shares also offer an attractive dividend with the forecast dividend yield 5.6% in 2015 and then 6% for 2016. While there are risks the diversification of the business makes it more resilient than its peer group.

This report was produced by Fat Prophets Senior Analyst, Andrew Latto