Prudential: Strong Fundamentals & High Dividend Yield (NYSE:PRU)

Overview

The last time I covered Prudential Financial (NYSE:PRU) was in August of 2023 and since then the total return has surpassed the S&P 500 (SPY). The price has moved upwards of 26% and the high dividend yield has pushed the total return near 30% since then. I thought it would be a good time to revisit and reassess whether or not PRU remains a Buy after the price run.

Since my initial coverage, some of PRU’s business segments have seen growth and the dividend has slightly increased. I don’t think PRU gets the recognition it deserves as a dividend growth stock so I will be focusing on that later on as well. Additionally, I believe PRU to still be a great buy despite approaching all time highs due to the continued segment growth and the authorization of a $1B share repurchase agreement initiated by their board.

In terms of valuation, I believe a fair price target to be $130 per share. This would represent a potential upside of about 12%. When you take this into consideration alongside a high dividend yield of 4.5%, you are looking at the potential to capture solid double digit returns.

Updated Financials

Prudential reported their Q4 earnings in February, completing their fiscal year results. The reported adjusted operating income for Q4 amounted to $943M which translates to $2.58 EPS (earnings per share). This is a slight improvement over the prior year’s Q4, which saw earnings come in at $932M and EPS amount of $2.42. To close off the fiscal year, the operating income for all of 2023 stood at $4.286B and an EPS of $11.62. This is in comparison to the prior year’s EPS of $10.31 for 2022.

The company’s total revenue reached $51BB and this comes from three main segments. The US based businesses which account for 49%, International business making up the second majority at 42%, and lastly the PGIM segment that accounts for 9%. PRU’s business is diverse but the majority of their revenue can be sourced from the premiums and annuities they receive from individual life and insurance based operations.

As of Q4, the amount of capital returned to shareholders was $708M. This includes $250M in share repurchases alongside the $458M that was issued out in dividends. I mention this because as of the last earnings call, the board has authorized $1B in share repurchases for the year of 2024. This is noteworthy because I believe further buy backs initiated at these levels mean that management has confidence in their ability to continually generate more returns. Not only that but it also has the potential to return more capital to shareholders by boosting up the price of PRU.

On the last earnings call we also received confirmation that PRU is making active strides to continue growing each segment of their business:

We continue to focus on diversifying our business by expanding in the under 5,000 live market and the association segment. We’re adding new products like supplemental health and continuing our growth and disability. And we made progress in that diversification effort, increasing our disability premiums and fees at a higher rate than before and our supplemental health premiums also grew at strong double-digit annual growth rates. And this diversification is driving stronger core earnings with higher margins. – Caroline Feeney, EVP and Head Of US Businesses

Segment Growth

Prudential brings in revenue from three main segments of their business: PGIM, US-based business, and International business. PGIM is the asset management arm that makes up the smallest portion of their earnings, accounting for only 9%. This segment of the business brings in $713M and continues to grow due to the diverse offering of attractive asset classes and performance. The percentage of AUM (assets under management) continues to outperform the public benchmarks. However, PGIM had lower revenues this quarter that was driven by lower incentive fees and higher expenses. Thankfully, this was offset by higher asset management fees.

The largest segment of their business is from the US based operations. This makes up 49% of their earnings and brings in approximately $3,792M. When I last covered PRU, this branch of their business was only pulling in $3,041M, meaning that the business segment has grown by $751M. This growth can also be attributed to the benefits of a higher interest rates alongside lower expenses.

Retirement strategies produced sales of $16.4B over Q4. Of this, individual retirement channels brought in $2.1B in sales and this is the highest level reached since before the pandemic in 2019. Fixed annuity sales have doubled and individual life sales have grown by 33% since Q4 of 2022.

Lastly, their international segment continues to show growth in the Japan and emerging markets. Sales of their international business are up 24% YoY. This segment accounts for 42% of their earnings contribution and amounts to $3,183M. I believe they will see continued growth around their product mix as the aging population provides an opportunity for expansion. In Japan for example, Life planner sales were up 21% due to recent product launches.

The other bulk of their international revenue comes from smaller emerging markets. Life planner sales were up 24% in the Brazil market. I feel confident in PRU’s ability to continue generating growth in the international space as they continue to reinvest back into the business and adjust fees as necessary. Each business segment continues to navigate the macro environment successfully without compromising the strength of their balance sheet.

Something that helps mitigate the risk is the cushion of cash PRU has on hand. Management states that have a liquidity goal between the range of $3 – $5B. As it stands, PRU’s cash and liquid assets currently sit at $4.1B, well within the targeted range. This should help offset any potential roadblocks or headwinds they face with the anticipated interest rate cuts in the latter half of the year.

Dividend & Valuation

Since my initial coverage of PRU, the dividend has been raised by 4%. As of the latest declared quarterly dividend of $1.30 per share, the current dividend yield is now 4.5%. The dividend grades here on Seeking Alpha are tremendous across the board and this is for good reason. The dividend payout ratio remains at a healthy level of 43.46%. While this sits higher than the sector median dividend payout, it’s still at a level that can support further growth.

In addition, the dividend growth has been spectacular. Over the last five year time frame, the dividend increased at a CAGR (compound annual growth rate) of 6.42%. More impressively, zooming out to a 10 year horizon results in a dividend CAGR of 10.5%. This is great considering the dividend yield is already high to begin with. For reference, the sector median dividend is only 3.5% so to have growth this large is quite impressive. PRU has also maintained a pretty consecutive dividend raise streak of 15 years which further instills confidence in management’s ability to continue paying an increasing dividend.

The average Wall St. price target sits at $109.15 per share. This means that the stock is currently overpriced by about 6%. The highest price target is only $118 per share and the lowest is $99 per share. I anticipate a price target upgrade eventually, especially when you consider the previously mentioned $1B in share repurchases that will take place over 2024.

However, I decided to run my own dividend discount calculation to determine a fair price target. I first compiled the data for all of the annual dividend payout amounts dating back to 2018. We can see that the average annual dividend growth since then has been 6.36%. I then used an assumed growth rate of 6% to align with the long term average. Full year sales were up 11% but I aim to take a more conservative approach with my outlook as conditions can easily change based on the macro environment. As a result, I come to an estimated price target of about $130 per share. This translates to a potential upside of 12%.

The potential upside of 12% is enticing enough for me due to the previously mentioned growth of each business segment. When you add this in combination with the already high yield 4.5%, we have the ability to capture double digit upside from these levels. Therefore, I plan to add to my position at some point this quarter to take advantage.

Risk

As we are likely to remain in an environment where interest rates are higher, PRU may have the challenge of a potential drop in the value of their assets. Since the business model is reliant on revenue from insurance annuities and premiums, they are dependent on the premiums amounting to more than what they have to pay out for claims.

PRU’s price may also detest the previous highs. The price is not as attractive as it once was. My personal price target is $130 per share but if you look at some other valuation metrics, the stock may seem a bit expensive at the moment. For example, PRU currently trades at a P/E ratio of 8.64. Meanwhile, the average 5 year P/E ratio is only 8.01. With an adjusted book value of about $96.64 per share, the price may remain stagnant until the next few quarterly results where we can have a better sense of what the future growth will look like.

Takeaway

Prudential remains a dividend growth stock that does not get the recognition it deserves. With over 15 years of consistent dividend raises, a higher dividend yield of 4.5%, and a solid dividend compound annual growth rate, PRU deserves a spot in any dividend growth focused portfolio. In addition, PRU may be undervalued based on the dividend discount model that I previously shared. My current price target is $130 per share, which works out to an approximate upside of 12%. When you combine this potential upside with the large dividend yield of 4.5%, you are looking at some solid potential double digit growth.

Business segments in the US and International markets continue to show growth in key areas. With an agreed upon $1B in share repurchases, I do believe we will eventually get a boosted price target from Wall St. This share repurchase agreement further bolsters management’s confidence in their ability to continue generating returns for shareholders.