Prudential Financial Stock Is Trading Above Its Fair Value

[Updated 12/04/2020] Prudential Financial Update

Having gained more than 100% since the March bottom and at its current price of just below $79 per share, Prudential Financial stock (NYSE: PRU) is 10% above its fair value of $72 – Trefis’ estimate for Prudential Financial’s valuation. In its recently released third-quarter results, PRU beat consensus earnings estimates, while the revenues underperformed. It reported total revenues of $15.42 billion, which is 2% more than Q3 2019. This could be attributed to a 5% growth in the international insurance business coupled with a 12% rise in the U.S. Workforce Solutions division. Notably, Net Realized investment gains (losses) decreased from $853 million in Q3 2019 to -$79 million in the last quarter.

We expect the company to report $60.9 billion in revenues for 2020 – around 6% lower than the year-ago period. Our forecast is based on our belief that the economy is likely to see some improvement in the last quarter, benefiting the total premiums amount and net investment income. The net income for the year is likely to be reduced by 12% due to higher operating expenses, reducing the EPS figure to $9.11 for FY2020. Thereafter, Prudential Financial revenues are expected to touch $62.7 billion in FY2021, mainly driven by growth in the international insurance business. Further, the net income is likely to see some improvement, leading to an EPS of $10.12 for FY2021. This coupled with a P/E multiple of just above 7x, will lead to the valuation of $72.

[Updated 9/01/2020] Prudential Financial Stock Has A Limited Upside

Prudential Financial stock (NYSE: PRU) lost almost 59% – dropping from $95 at the end of 2019 to around $39 in late March – then spiked 73% to around $68 now. But that means it’s still 28% lower than where it started the year!

There were 2 clear reasons for this: The Covid-19 outbreak and economic slowdown meant that market expectations for 2020 and the near-term consumer demand fell. This is likely to impact the insurance premiums and net investment income, which are the two main revenue sources for Prudential Financial. However, the multi-billion-dollar Fed stimulus in late March helped arrest the negative market sentiment, which is also evident from the stock recovery after that point.

But, we think Prudential Financial’s stock has already achieved its growth potential and has limited further upside

Trefis estimates Prudential Financial’s valuation to be around $71 per share – slightly above the current market price – based on an upcoming trigger explained below and one risk factor.

The trigger is an improved trajectory for Prudential Financial’s revenues over the second half of the year. We expect the company to report $60.4 billion in revenues for 2020 – around 7% below the figure for 2019. Our forecast stems from our belief that the economic scenario is likely to show some improvement in Q3. The recently released consumer spending data in the U.S which shows a m-o-m growth of 8.5% in May followed by 5.6% m-o-m in June give further weight to our expectations. If the trend continues in the coming months, it is likely to improve both, the net premiums figure and income from investment of insurance premiums. The latter is very critical for the profitability of an insurance company and has improved due to the recent improvement in the securities market. This, in turn, would benefit the revenue trajectory over the coming months. The net income for the year is expected to drop to $3.6 billion – down 14% y-o-y, reducing the EPS figure to $9.14 for FY2020.

After that, Prudential Financial’s revenues are expected to improve to $62.1 billion in FY2021, mainly driven by growth in U.S retirement solutions and international insurance segments. This is likely to enable the EPS figure to touch $10.09 for FY2021 – up by 10% y-o-y.

Finally, how much should the market pay per dollar of Prudential Financial’s earnings? Well, to earn close to $10.09 per year from a bank, you’d have to deposit around $1110 in a savings account today, so about 110x the desired earnings. At Prudential Financial’s current share price of roughly $68, we are talking about a P/E multiple of around 7x, which we think is appropriate.

That said, insurance is a risky business right now. Growth looks less promising, and near-term prospects are less than rosy. What’s behind that?

Prudential Financial is a global insurance company with around $768 billion in identifiable assets between its U.S and International insurance segments (as per FY 2019 data). The company drives around 22% of its total revenues from income generated by the investment of insurance premiums. Hence, its business model is very sensitive toward changes in investment yields. While the broader markets are on a growth trajectory (up 55%) since the March bottom, any further deterioration in the economic condition or an unanticipated jump in the Covid-19 case count can reverse the momentum and could negatively impact the PRU’s top line.

The same trend is visible across Prudential Financial’s peer – American International Group. Its revenues are also expected to be reduced in FY2020 due to lower premiums and a drop in investment income. Further, American International Group’s stock is currently trading at a price of around $30 but looks slated for an EPS of around $3.53 in FY2021.

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