Why high-yielding L&G is 'too cheap'

The widely-held assumption that we will continue to live for longer was dashed by Legal & General's CEO Nigel Wilson today, triggering an unexpected £126 million windfall for the insurance and investment management group.

Rising life expectancies are painful for the likes of L&G because it means they need to set aside more reserves to cover future insurance and pension payments. But, having reviewed longevity assumptions, L&G said it was able to release £126 million from its reserves on the basis that it believes the recent trend for improvements in life expectancies is slowing.

There's also the potential for a further release at the year-end. L&G said: "If recent mortality improvement experience continues, we would expect to fully reflect this in our assumptions over several years as the credibility of the data increases."

While that's bad news for most of us, it's good news for L&G and its shareholders, who stand more chance of getting a return of cash from excess capital.

The longevity review provided the main surprise in half-year results, which offered further signs of progress with the insurer's strategy and business model as it positions itself to benefit from six long-term growth drivers. These include ageing demographics, the impact of welfare state reforms and the globalisation of asset markets.

L&G delivered 41% growth in earnings per share (EPS) to 15.9p in the six months to June, 41% growth in profits to £1.2 billion and a 26.7% Return on Equity, highlighting why the stock continues to trade at around levels last seen at the end of 2015.

The shares pulled back a bit today, but Panmure Gordon analyst Barrie Cornes said there was no reason to think there's not more to come from the blue-chip stock.

He maintains his 'buy' recommendation and 305p target price, noting that the strong results and cash position point to a full-year dividend yield of 5.6%.

Cornes said: "Trading on a 2018 FY PE multiple of 11.3x based on our forecast, the shares are too cheap and should be bought."

The interim dividend increased by 7.5% to 4.3p, in line with the new formulaic dividend approach of 30% of the previous year's full year dividend.

L&G said: "Our financial ambition is to achieve a similar performance in 2016-2020 as that achieved in 2011-2015; where EPS grew by 10% per annum and net release from operations by 10% per annum."

Most of the company's operations are in the UK, but it's growing rapidly in the United States and has less mature international business in Europe, the Gulf and Asia.

In the UK, L&G has enjoyed success managing and de-risking defined benefit pension assets.

As these schemes struggle to meet their promises, L&G offers a range of solutions such as buying out liabilities using bulk annuities and helping set up more affordable defined contribution schemes.

The company said it wrote more than £1.6 billion of bulk annuity business in the first half of the year, more than double the figure for a year earlier. Meanwhile, assets under management at its investment management business rose 13% to £951 billion.

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