Prudential plc

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 3/5

Prudential plc is a multinational insurance and asset management company with a significant presence in Asia and Africa. They provide a diverse range of insurance products including life, health, and accident insurance, as well as savings and investment products.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Prudential plc (PRU), commonly referred to as Prudential, is a diversified financial services giant with roots stretching back to 1848 in London. Today, it focuses primarily on life and health insurance, and asset management in Asia and Africa. Here’s a deep dive into their business:

Revenue Distribution

Prudential has undergone a significant shift in its operations recently. It exited the US market in 2021, when Jackson Financial was separated. Also, it divested its European business in 2022, including the headquarters for European operations in the UK and Asia. Therefore, it has now become an Asia and Africa focused company.

The company has a streamlined structure now:

  • Life and Health Insurance: This is the core of Prudential’s business, providing a range of life and health insurance products to a diverse customer base in Asia and Africa. This is a highly profitable business and accounts for the majority of the group’s revenues.
  • Asset Management: Operating primarily under the Eastspring Investments brand, this segment manages assets for institutional investors. This segment is a growing source of income for PRU.

The insurance industry in Asia and Africa is characterized by several key trends. This region represents an attractive growth market for insurance as well as asset management due to high economic growth, a growing middle class, rising health awareness, increasing financial literacy and relatively low insurance penetration.

Here are some key trends:

  • Growth in Emerging Markets: The middle class in Asia and Africa is growing and becoming more sophisticated about their financial planning and insurance needs.
  • Increased Awareness and Demand for Health Insurance: As healthcare costs rise, there’s an increased interest in health insurance coverage.
  • Technological Advancements: The use of technology has helped insurers with more efficient distribution, data analytics, better customer experience, and fraud detection.
  • Regulatory changes: Regulations are becoming stricter in many countries, requiring more capital and more transparency.

Margins

Prudential’s profitability is influenced by several factors, such as claims frequency and severity, investment income, and expenses. Looking at the segment results provided for 2022 and 2021:

  • Profitability from continuing operations: 2022 APE basis: (4,255 - 3,177 = 1,078 million), 2021 APE basis: (3,917 - 3,300= 617 million) which represents a good improvement. Although profitability increased, it is also offset by high expenses.
  • Net Earnings (2022): The net income of the group was impacted by the higher interest rates, which resulted in realized losses on fixed income investment of the company.
  • ROIC: The return on invested capital (ROIC) of the Insurance business was high in the past, but in recent times, the ROIC is not high enough to offset the cost of capital (WACC). Management are focusing on improving ROIC in the future through cost-saving and improving revenue.

Competitive Landscape

Prudential operates in a highly competitive environment, both within and across geographies. In Asia, Prudential competes with a wide variety of local and international insurance and asset management companies such as AIA, Manulife, Ping An, and China Life. The competition in the industry is characterized by differentiated products, competitive pricing, and a strong focus on the customer.

Here are some relevant factors:

  • Intense competition: Low barriers to entry in asset management make it extremely competitive and pricing pressure is high in this market.
  • Strong regional players: Many successful competitors such as AIA are entrenched in their core markets and are able to use their local knowledge and customer loyalty to compete effectively.
  • Digital innovation: As most companies are turning to digital capabilities, this has helped provide more efficient methods of reaching out to customers.
  • Brand recognition: Established brands can create stickiness among customers with a strong track record of performance.

What Makes Prudential Different

Prudential differentiates itself in a few ways:

  • Focus on Asia and Africa: The complete focus on Asia and Africa makes them an expert in this market which is quite different from that of their peers. The company has been in this region for a considerable amount of time and has created expertise.
  • Strong distribution: Prudential employs a unique, multi-channel distribution network, where it partners with banks, agents, and digital platforms to reach out to all the customers.
  • Established brand: Prudential has a long history of offering financial services and has created a loyal customer base.

Financials

Prudential’s financial health can be gleaned through an analysis of its balance sheet, income statements, and cash flow:

Balance Sheet Health: 3 / 5

  • Capital: The company’s solvency is determined by the level of their regulatory capital, and the solvency margin was at 337% at 2022-end, which is much higher than the regulatory requirement. The company has strong capital buffers for its financial commitments.
  • Debt Levels: The group has a leverage ratio above 30 percent on average, with debt constituting more than 30 percent of its total capital which is a cause of concern for investors.
  • Credit ratings: Prudential is a large financial institution and has to maintain a decent credit rating for its operations. The group is currently rated BBB+ (S&P), Baa1 (Moody’s), and BBB+ (Fitch).

Overall, the group has a decent balance sheet with some concerns about financial leverage, but that has not posed a threat to the overall group. This has led to a rating of 3 on our 5-point scale.

Earnings and Cash Flow

  • Earnings growth: Earnings has generally been good, but can vary due to market conditions, claims volume, and currency fluctuations. A notable recovery in the Group’s APE basis performance was noted in 2022, primarily from strong sales in their key markets.
  • Reinvestment & Divestment: The company does not have high capital expenditure requirements to maintain operations. But they are focusing on investing in strategic initiatives such as expansion into new markets, and they also divest business segments, to focus on the more core business. The proceeds from the divestments could be either reinvested in growth opportunities or returned to shareholders.
  • Cash Flow: The free cash flow of Prudential is mostly affected by the premiums collected and the payouts given under their various contracts. In 2022, cash flows were negatively impacted by the increase in interest rates. The free cash flow remains at a good level. The strong level of cash from operations gives it flexibility and stability.

Management Discussion on Challenges

In recent earnings calls, management mentioned that there was macroeconomic uncertainty and volatility of the markets which resulted in lower investor returns, and lower revenue growth for some segments. Some of the key challenges faced by the company:

  • COVID-19 Related disruptions: Continued impact from COVID-19-related restrictions and changes in business and consumer behavior.
  • Global Economic Uncertainty: Global economic downturn and the risk of a recession or slow growth which may affect earnings, and market volatility which can affect valuations of their investments and securities.
  • Inflation and Interest Rate Changes: Increased inflation and interest rate hikes which increased their costs and impacted their profitability.
  • Regulatory changes: New regulations and compliance requirements which may impact the earnings of the group.

Management has also stated how they are dealing with these challenges:

  • Efficiency Measures: The company is focusing on cutting costs and streamlining operations to improve the efficiency and profitability of the company.
  • Strategic Expansion: The company is expanding its operations to new markets and also is focusing on growth of its existing markets.
  • Product innovation: The company is using technological developments for product innovation and enhancing customer service.
  • Capital Allocation The company has a very disciplined approach to capital allocation, and is careful in managing its cash flows and balance sheet.

Moat

An economic moat is a sustainable competitive advantage that enables a company to fend off competition and maintain profitability over an extended time.

Prudential does have some characteristics that enable it to carve a competitive advantage over their competitors. The sources of its competitive advantage are:

  • Established Brand: Prudential has a history of operating for nearly 175 years. This has given it strong brand recognition and established trust among its customers, which may result in better brand recognition and better customer retention.
  • Large distribution networks: The company has a large network of agents, bancassurance partnerships, and digital platforms to efficiently reach out to its clients. This broad distribution network gives them an advantage over smaller competitors.
  • Strong operating metrics: The company has demonstrated good metrics for financial strength and solvency which is an attractive proposition for a financial services institution.

However, the company has certain weaknesses which will make it hard for them to sustain a wide moat:

  • High degree of regulatory oversight: As an insurance company, PRU operates under many regulatory bodies from various countries. This could result in increased costs and operating complexities.
  • Competition: As mentioned before, competition in insurance is very intense and many local players in Asian and African markets will give them good competition.
  • Limited Pricing Power The company’s pricing is limited by market forces and competition. It might not be able to increase prices at will.

Therefore, considering the positives and the weaknesses, and the intense competition that exists in this industry, PRU has a Narrow Moat, and I am giving it a 2 out of 5 score.

Understandability: 4/5

The nature of the insurance business, involving long-term contracts, future risk assessment, actuarial predictions, different rules for operating companies and investment portfolios, is extremely hard to get a full grasp of all the aspects. However, at a high level, their main operations are easy to understand, that is insurance and asset management, so they can be readily understood at a high level by an average person. The main reason the business gets the rating of 4 out of 5 is the complex calculations and analysis involved in the business. Therefore, the business gets 4 out of 5 in our scale of understandability.