Prudential is a great business. But we don''t see how it can avoid headwinds to its major growth driver: Mainland Chinese buying life insurance in Hong Kong. And we don''t think the comparative Balance Sheet exposure is well understood. We initiate on Underperform.
Don''t get us wrong - we think this is a fantastic business
The go-forward business in Asia has major competitive advantages in distribution. And the drivers of Asian life insurance growth are powerful. This should allow the business to redeploy earnings above its cost of capital - making Prudential a classic compounder.
But Mainland Chinese purchases in HK have driven the growth - and we see headwinds
But look closer, and Asian growth over the past several years has actually been propelled by Mainland Chinese tourists buying life insurance in Hong Kong, making up c.35% of total Asian New Business Contribution in 2019. Prudential has done a great job of capturing their business. But we think political, economic and healthcare trends are going the wrong way, reducing the incentives for Mainlanders to buy insurance in Hong Kong. This note deep-dives the reasons we expect growth to tail-off.
Plus, the business model creates underappreciated balance sheet risk
17% of Pru Asia''s fixed income portfolio is invested in High Yield debt. And equity allocations also benchmark high. Is this recklessness? No: this is a necessary consequence of selling certain kinds of insurance products in countries with lower credit ratings. Nonetheless, this creates a degree of risk that needs to be taken into account in the cost of equity.
Putting a price on the US business (Jackson), and valuing the go-forward Asian business
We think Pru Asia deserves a lower P/E than AIA due to the comparative growth outlook, asset allocation and debt leverage. We think the pricing of Athene''s capital injection into the US business Jackson implies that Pru will receive proceeds of c.USD3.2bn from the IPO (plus USD1.8bn...
