Stockwatch: A fruitful long-term investment

Is retirement income firm Just Group (JUST) shaping up with a sound investment profile, post-merger?

Just Retirement Group and Partnership Assurance got together between August 2015 and April 2016 to create the £1.5 billion entity. It was designed to offset sliding annuity sales after 2014 government reforms liberated pensions, offering specialist packages and large corporate pension deals.

In 2014, Just’s share price slumped from 272p to 120p on fears for annuity-related revenues. It then remained volatile sideways, touching an 86p low after the EU referendum.

The chart was effectively saying the FTSE 250 (MCX) business had turned high-risk, non-investment grade. But since the merger was declared it has been in an overall uptrend, despite volatility between 122p and 162p this year.

Latest interims to end-June affirm synergies and, although the group’s financial profile remains bumpy, the industry context should be fruitful for long-term investors.

Demographics offer a growth context

Ageing British baby boomers mean a political dilemma by way of wealth concentration in society. But they also offer an opportunity for adept financial services, one that’s potentially able to resist a consumer downturn linked to lower disposable income, starting to affect discretionary goods and services.

Low interest rates have made annuities unattractive, spurring a drive for alternatives.

The merged group serves four distinct areas: retirement income, an estimated market worth over £1 trillion where people have built up a defined contribution pension and seek guaranteed or flexible income, or a mix of both; homeowners aged over 60 wanting to access wealth locked up in property, estimated at £2.3 trillion for those aged over 50; corporate clients needing retirement solutions; and trustees to de-risk their pension liabilities with an insurance contract.

Management proclaims: “We positively disrupt markets where we can become a leader, deliver great outcomes for customers and high-quality returns for shareholders.”

The relatively specialised products involve: guaranteed income for life; flexible pensions; care plans and lifetime mortgages, altogether with a scalable operating model. If management can execute this well enough then it ought to deliver useful growth.

Latest interim results show operational benefits

Adjusted operating profit is up 39% to £67.2 million in the six months to end-June, despite total revenue down 10% to £1.22 billion, as like-for-like net premium revenue and net investment income varied inversely. A mid-July update cited £40 million cost savings achieved over a year ahead of plan and revised up to £45 million.

Chief executive Rodney Cook adds: “Careful risk selection is delivering margin expansion and demonstrating the value of our pricing approach.” Thus, new business margins rose from 5% to 8.9%.

Volume growth is also principally from new business, where defined benefit sales jumped 80% to £296 million, the like-for-like comparison being enhanced by last year’s pricing disruption after the Solvency II regime raised capital requirements.

A strong pipeline in defined benefit sales is cited for the seasonally busy second half of 2017, and this segment helped total first-half retirement income sales advance 16% to £720 million.

Otherwise, guaranteed income for life (GIfL) products eased 2% to £390 million, in a mixed profile with Q2 sales 24% higher than Q1 as transfers increased.

Care plans fell 41% to £34 million, reflecting a renewed emphasis on risk selection, but also uncertainty around the general election. Lifetime mortgage loans were also down, by 28% to £230 million and without much explanation.

Altogether, it meant total new business sales edged up only 3% to £975 million, hence it seems early to assert whether the segment’s volatility is settling.

Possibly the share price did little in response than bump around 160p, also because it’s suggested margins may normalise – i.e. slip a tad – in the second half.

But, despite the mixed results, management is positive about H2 onwards: GIfL is expected to benefit from demographics, pension scheme transfers and continued shopping around. Lifetime mortgages are expected to benefit from more people reaching retirement with greater wealth in housing than pension assets.

Just Group – financial summary           Consensus forecasts year ended 31 Dec 2012 2013 2014 2015 2016 2017 2018           18 months     IFRS3 pre-tax profit (£m) 24.7 78.3 92.8 -29.6 132     Normalised pre-tax profit (£m) 24.7 78.3 100 -29.6 177 101 164 IFRS3 earnings/share (p) 2.9 16.2 16.2 -5.0 13.3     Normalised earnings/share (p) 2.9 16.6 16.8 -5.0 19.3 13.5 17.2 Normalised EPS growth (%) 2,333 470 1.3     -30 27.3 Price/earnings multiple (x)         8.4 11.9 9.4 Annual average historic P/E (x)   11.7 10.7 9.2   7.3   Dividends per share (p)       3.3 1.5 3.7 3.9 Yield (%)         0.9 2.3 2.4 Covered by earnings (x)         6.5 3.7 4.4 Net tangible assets per share (p)     155 148 149     Source: Company REFS               Strong asset backing, increased balance sheet flexibility

Financial and reinsurance assets predominate; intangibles being a modest 12.4% of net assets and cash up from £71.4 million to £155 million, or 16.6p per share.

Debt remains stable at £343 million for modest gearing of 20.8%, although total finance costs rose from £73.8 million to £103 million, representing interest costs on reinsurance deposits and financing, plus interest on Tier 2 notes.

Management is working to reduce its cost of capital via access to a new £200 million revolving credit facility agreed “on attractive terms”, for example, as well as inaugural investment grade credit ratings for the group’s key companies.

Thus, finance costs ought to reduce henceforth. The group’s solvency ratio – capital available as a proportion of the minimum required – is flat at 150%.

End-June “embedded value” was £2.06 billion, or 221p per share, up from 219p at end-December 2016, this representing shareholders’ funds plus the value of in-force business – a key measure to assess future profit streams and additional value of profits on the books, yet to be accounted for.

The increase reflects the value of new business written during the period less the 2016 final dividend.

Valuation measures touted can appear subjective. An analyst at Panmure Gordon (which has no commercial relationship) contends the stock remains “very attractive” at a 27% discount to Just Group’s end-June enterprise value.

For the most part, private investors are likely to find such approaches a tad technical, with an eye instead to the expected dividend yield, which, sub-2.5%, is modest albeit with strong earnings cover of about 4 times.

So, the stock is no real use for income, yet should be supported by underlying asset measures.

Risk/reward profile therefore tilts positively

The investment rationale is somewhat speculative given this mixed operational review, yet the merger is delivering operational benefits in an industry context with favourable demographics, George Osborne’s reforms shaking up pensions, and the challenge to convert housing wealth into income.

The financial record lacks proven growth capability, seemingly jagged like the chart. But if management can genuinely carve out a lead-position with specialist products, this business is going places hence, taking a multi-year forward view, its stock rates a tuck-away.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.