Jackson Financial: Misunderstood Yet Attractive (NYSE:JXN)

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Jackson Financial (NYSE:JXN) is significantly undervalued at this level. While you wait for the market to recognize that, the company itself is buying back stock and you as the shareholder collect a 6.5% yield.

I think many investors do not recognize this opportunity because, well, Jackson Financial has messy financials (what a pun). By the way, so do most life insurers or annuity providers. That is part of the industry’s regulation and accounting requirements, and it’s probably a large part of why Prudential (PUK) decided to spin off Jackson in 2021 (more on that later). It’s also the reason why many people seem to struggle to fully understand the investment case here.

I have seen Jackson Financial being described as a “black box asset,” and I have some sympathy for that view. I’m no insurance and annuity expert either, and if the business wasn’t so unbelievably statistically cheap, maybe I would have put this one in the infamous “too hard” pile and moved on as well. However, after having studied the annual reports and the demerger agreement extensively, I don’t think it’s that much of a black box after all. Here’s my insight and best take on what to make of this company and the underlying business value.

So, what do they do?

Jackson Financial is the leading (in most segments, but at least ranked No. 2 in others) retail annuity provider in the U.S., its sole and target market. Annuities come in all shapes and forms, but the basic principle is always the same: Customers go to an entity like Jackson to have their money invested for them, primarily in a way that will provide reliable periodic payments at a later stage. As one would expect from the market leader, Jackson has competitive product offerings in all relevant annuity segments, although the variable annuity account value comes in as by far the largest piece of the pie.

The annuity provider by definition has no easy task: You have long-term liabilities to meet your policyholders’ claims, and you have to invest assets in a way that creates yield for the customer (and, preferably, a little something for yourself too). All the while you have to manage your risk and exposure to different markets, and you have to be flexible and liquid enough to meet potential customers’ withdrawals. All of this requires specialized, actuarial knowledge to run and, possibly, to evaluate it. You have to be exceptional at managing risk, and you really can’t have big screwups.

Why Jackson is a good business, but not a great business

Annuities are ultimately a fungible product. Customers do not care too much about their annuity’s provider as long as they are legitimate and sufficiently solvent. They care more about the attractiveness of their yield vs. other options and the product features. This is where Jackson possibly shines as the leading provider of scale: They can offer the top products, and it seems as if they really have a differentiated product line with lots of product variations. They try to innovate on the customer’s behalf and have, for example, recently offered new so-called “RILA” (registered index-linked annuity) products as a response to current industry trends. The RILA category has witnessed rapid growth in the recent past, having grown at a CAGR of 81% from 2015 to 2020, as we can learn from their 2021 annual report.

They seem to have a lean and efficient operating platform and are among – if not the – lowest cost operators in the industry, which should enable them to offer better yields and more relevant products for customers. JXN has existed since 1961, so they seem to be good at what they are doing. After being founded in 1961 and having reported assets of $650,000 in their first year of business, the company’s total assets under management come in at roughly $300 billion as of its latest Q3 2022 results.

As for moat, there appears to be some due to strict regulation when it comes to entering or operating in the financial and insurance market as a big provider in all U.S. states. To get the approvals, all of the licenses and everything else would probably require a fair amount of effort by any competitor.

There are also some structural tailwinds to the investment case. The aging U.S. population will result in continued growth as more and more older people approach retirement age, have assets to invest, and wish for income security other than state or private pensions. According to the demerger filing, “structural changes could more than double the size of [their] addressable market.” If JXN manages to keep offering attractive annuity products to a significantly expanding target market, assets under management and associated fee earnings might grow handsomely into the future.

In addition, they are probably at a cyclical low in the business cycle as interest rates have just emerged from literally historical lows, and, generally, rising interest rates make for higher (new) annuity yields for customers and for more attractive products. This is not a 1:1 positive, as people might terminate older, less-attractive policies and equity values might go down because of interest rate hikes (see 2022 for details). This subsequently leads to market-linked annuity products sinking in value, which in turn results in Jackson’s asset-based fees sinking and so on. However, it is generally good for insurance companies and other financials, like banks, when interest rates rise and they earn more on their assets. They are actually the primary beneficiary among the small group of industries that benefit from high(er) rates.

Jackson’s origins and why this opportunity exists

Jackson Financial was (partially) spun off from Prudential (meaning they maintained an equity stake) in September 2021. Every shareholder of 40 PUK shares received one share of JXN. Prudential is, of course, the global life insurance giant with roots in the UK. As spin-off transactions usually do, the circumstances of the transaction created a really depressed share price for Jackson in the first year or so as a standalone public company. Here’s a short overview of the factors that contributed to the current mispricing of the shares:

1. Prudential wants to focus on growing African and Asian markets and clearly, they want their stock to be recognized as a growth story. So they decided to give investors pure exposure to growth markets and divest from old, boring, legacy U.S. annuities with volatile earnings. As Prudential is by far the larger business and operates in different markets, most institutions that held PUK were inclined or potentially required to dispose of their JXN shares.
2. JXN has to report earnings in a pretty volatile fashion under U.S. accounting standards, which makes it difficult for market participants to recognize the underlying business’ true value.
3. Prudential declared that even after the demerger, they would continue to sell their remaining equity stake until September 2022 so that they would end up with just below 10% interest in JXN. So first they are spun off, and then the parent company publicly declares to keep selling stock? That is a pretty bad setup.
4. There even was an automatic selling option provided by Prudential to help minor shareholders to instantly sell their JXN stock (look for “share sale option” in the abovementioned demerger statement). As we can see, the hurdle for selling JXN after the deal went through really wasn’t that high.

It was only relatively recently (September 2022) that the time ended for Prudential to sell its remaining equity stake as specified in the demerger agreement. As such, now might actually be the prime time for opportunistic purchases by the enterprising investor, if carefully examined and deemed an attractive investment opportunity.

Jackson Financial’s statistics

Jackson Financial has a market cap of $2.82 billion as of Dec. 28, based on a share price of ~$34. The enterprise value currently is $1.9 billion, which is a by-product of the significant liquidity the business has (and is prudent to have).

There are roughly 88 million fully diluted shares outstanding as of the end of 2022 vs. 94.5 million in December 2021, which is a great thing and shows that they have bought back their own stock. This means the share of the pie for each existing shareholder has increased and apparently management thinks the stock is cheap. Overall, this means there are roughly 6.9% fewer shares outstanding, which is a figure that should be included in calculating total capital return for you as the shareholder. Performing elementary school math and adding up ~6.5% in dividend yield and ~6.9% in buyback yield, we arrive at 13.4% in total capital return for 2022, which is simply outstanding.

In their reporting, they provide a so-called “financial leverage ratio,” which is down to 17.5% as of Q3 2022 from 22.9% as of year-end 2021. This is yet another positive sign. They have communicated in the past that they are committed to keeping that leverage ratio small and below 25%. This is a pretty conservative number, showing that they are far from overleveraged and have a really strong balance sheet that could sustain some future adversity.

They have $5.44 billion in cash on hand, which exceeds both their market cap and their total debt (hence, the lower enterprise value). As an insurance/annuity company, of course, they have to maintain significant liquidity at all times. As for the dividend yield, their latest annual payout was $2.20. So, divided by the current stock price of ~$34, we arrive at a figure of 6.47%. That is nothing to sneer at whatsoever, and another enticing data point.

Sales, earnings, and book value are not as easily quantifiable at first glance as these financial websites’ data make you believe, and they will require further commentary below.

Quantitative analysis

One thing upfront: When you read their quarterly results, the annual reports, etc., it becomes evident rather fast that GAAP net income really isn’t the best proxy for earnings power of the business, as it is extremely volatile and does not really reflect current business developments. It takes into account all the movement of the company’s hedges, which are primarily in derivative instruments, and match the company’s liabilities (policyholder claims) duration-wise. This is not quarter to quarter. They might zig when the market zags (at least that’s my insight).

When you use net income you had a large profit in 2021 (more than the current market cap), but losses in both 2020 and 2019. In 2020 there was a one-time charge from the Athene (reinsurance) transaction, which also reduced that year’s net income, but it really was non-recurrent in nature. Management uses adjusted operating earnings, adjusted book value, and thus adjusted return on equity as supplemental measures of business performance. As far as I can tell, this seems to make sense and seems to be the superior measure. I read the explanations and the reconciliation of non-GAAP to GAAP metrics to get an understanding; again, I’m not an insurance expert, but what they described sounded sensible and it does indeed strike me as foolish to base a valuation on the wildly swinging accounting net income figure that is so volatile. So, in my valuation, as to earnings power I will take a three-legged approach:

1. based on net income,
2. based on adjusted operating earnings provided by management, and
3. based on twice the amount of capital returned to shareholders for the full year (dividends and buybacks).

In their policy, they mention a payout ratio of about 40%-60% of their annual change in excess capital via buybacks and/or dividends. While probably not a perfect measure, I think this might be as close to a proxy for distributable earnings as we can get for this kind of business. Hence, we will use this change in excess capital (calculated as twice the payout amount) for our purposes of valuation. Actually, the capital return figure increased in the aftermath of the September 2021 demerger. In the 2022 results (Q1, Q2, and Q3 are published so far), management now talks about a full-year capital return target range of $425-$525 million, of which they expect to achieve the higher end. Let’s peg it at $500 million in capital return during 2022 for the sake of this analysis.

Book value/stockholder’s equity

The company appears to be trading at about a third of their book value – one of the most fundamental measures of value. Their latest Q3 2022 results suggest ~$9 billion in stockholder’s equity, net of any minority interest.

Here’s a look at how book value/total stockholder’s equity (GAAP) behaved over time (in billion $):

2022	2021	2020	2019	2018	2017	2016
9.56	10.39	9.54	6.77	7.47	7.31	6.97

Click to enlarge

From 2016 until now, book value grew at a CAGR of 5.41%. Book value growth for JXN basically tells the story of a stable business with some small growth in the past.

The questions arise at this point (at least for me) are the following: What is up with that price discrepancy? Is that justified? Should it be worth book? Are other financials and insurance companies generally worth book? If so, this screams undervaluation. According to Investopedia:

… a quick rule of thumb for insurance firms (and, again, for financial stocks in general) is that they are worth buying at a P/B level of 1 and are on the pricey side at a P/B level of 2 or higher. For an insurance firm, book value is a solid measure of most of its balance sheet, which consists of bonds, stocks and other securities that can be relied on for their value given an active market for them.

So it seems as if, generally, insurance companies and financials should be worth (1x) book value (at least). That makes sense. I am beginning to believe Jackson at 0.32x book does not make sense.

What about sales/total revenues?

For full-year 2021, they had revenue of $8,848 million. That would put the price/sales ratio at 0.32. For the first nine months of 2022, they already had more revenue at ~$15 billion. But, again, revenues take into account the wild swings in hedges and derivatives, so I think it’s probably wiser to look at revenues as the sum of premium revenue, fee revenue, ordinary net investment income, and other income. Using this methodology, we arrive at $8 billion for the first nine months of 2022 (let’s call it $10.5 billion full-year extrapolation): a 0.27 P/S ratio.

Calculated this way, total revenue for full-year 2021 was $11.34 billion, full-year 2020 was $9.65 billion, 2019 was $10.2 billion, 2018 was $14.177 billion, 2017 was $9.66 billion, and 2016 was $9.1 billion.

So, what can we learn from that? First, that it’s a rather resilient business with some (minor) growth in the past, meaning that operating revenue ex-hedging is higher now than in 2016, although not by a spectacular amount, and not in a particularly steady way. Second, from the numbers we can see that in all of the recent years, hedging returns have been a drag on revenues and GAAP profits, and 2022 seems to be the first year that the hedges produced substantial gains and added to total revenues (and profits). This makes sense and shows that hedges are there to protect against nasty down markets, which worked beautifully in 2022.

Prior to 2022, the losses in hedging might be attributed to very favorable market conditions and rising markets. It was a long period of sunshine. This might change in the next few years, and underscores the need for the hedges to mitigate risk and decrease cyclicality. A disadvantage and drag on revenue suddenly becomes an advantage and boost. However you want to calculate it, the P/S ratio suggests the same thing the price/book ratio does: radical cheapness.

The primary driver of value: earnings power

I will use the methodology described above and take a three-sided approach, starting with the least useful and applicable metric, net income. The trailing 12 months figures reflect the period from Q3 2021 until Q2 2022.

Here’s a look at GAAP net-income (in billion $):

TTM	2021	2020	2019	2018	2017	2016
5,72	3.18	-1.63	-0.5	1.99	0.5	0.8

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Based on the TTM developments, the P/E would be 0.49. Based on FY21, the P/E would come in at 0.89. Based on the three-year average consisting of FY21, FY20, and FY19, the P/E is 2.67.

Here’s a look at non-GAAP adjusted operating earnings (in billion $) – which is, by the way, an after income-tax figure in JXN’s case:

TTM	2021	2020	2019	2018	2017	2016
1.77	2.4	1.88	2.04	1.68

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Based on the TTM developments, the P/E would be 1.58. Based on FY21, the P/E would come in at 1.17. Based on the three-year average consisting of FY21, FY20, and FY19, the P/E is 1.33.

Here’s a look at 2x the capital return to shareholders figure for full-year 2022:

2x 500 million USD = 1.0 billion. 2.8/1.0 = 2.8

The P/E ratio for this figure (the reasoning is outlined above) would thus be 2.8. Even based on the worst possible composition, you don’t arrive at a P/E ratio above 2.8.

How profitable is the business?

Let’s now look at return on equity (calculated by me as adjusted operating earnings divided by total stockholders’ equity) as a proxy for the business’ overall quality:

TTM	2021	2020	2019	2018	2017	2016
18.52%	23.1%	19.7%	30.1%	22.5%

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Let’s call 2019, the most profitable year, a statistical outlier. But even without it, average return on equity comes in at ~20% (we all like round numbers).

Is JXN stock a good relative value?

How does the valuation compare to similar companies in the same sector? The most logical comparison candidate would be former parent company PUK, of course. But also the S&P 500 Insurance Index and Financial Index should give us a general overview of fair or ordinary prices. Also, larger (public) annuity and insurance companies should make for worthy juxtapositions.

Valuation Metric	JXN	Prudential	MetLife (MET)	China Life Insurance (OTCPK:LFCHY)	Lincoln National (LNC)	Manulife Financial (MFC)	Aviva (OTCPK:AIVAF)	S&P Insurance	S&P Financials
Price/(tangible) book	0.31	4.02	0.97	1.78	0.28	0.92	0.8	1.09	1.47
Price/Sales(2021)	0.32	1.43	0.85	1.07	0.27	0.73	0.38	1.19	2.15
PE (2021 GAAP)	0.89	4.90	8.87	17,37	3.65	6.11	6.21	17.4	12.49
PE (GAAP 3-year average)	2.67	9.83	9.79	16.71	5.52	7.0	5.10	x	x
PE (2021 proxy figure)	1.17	6.72	7.08	x	3.31	7.17	5.48	x	x
PE (3-year av. Proxy)	1.33	7.39	8.73	x	4.08	7.23	4.33	x	x
3-year average ROE	18.30%	11.83%	11.10%	13.09%	9.00%	12.67%	11.13%	x	x
Dividend yield	6.47%	1.31%	2.79%	5.74%	5.93%	5.35%	6.68%	1.63%	2.01%

Click to enlarge

• The average (without JXN) of price/tangible book is 1.42
• The average (without JXN) of price/sales(2021) is 1.01
• The average (without JXN) of price/net income(2021) is 9.62
• The average (without JXN) of price/net income(average) is 8.99
• The average (without JXN) of price/earnings(proxy) is 5.95
• The average (without JXN) of price/earnings(proxy, average) is 6.35
• The average (without JXN) three-year ROE is 11.47%
• The average dividend yield is 3.93%

The results of the comparison

The average upside based on all these metrics would be ~375%. That would imply a potentially fair intrinsic value of ~$13.4 billion, or over $150 per share. By almost any metric, JXN is significantly undervalued, all while being the most profitable operator in the industry, as indicated by average return on equity. So now we have established just how cheap this business, which seems to be doing well overall, really is. Let’s round the analysis off with a few other relevant data points.

Insider buying and ownership structure

In addition to the company buying back its own stock, insiders have also been buying stock for their personal accounts (which is, of course, a great sign) and own more than 10% of the stock. Prudential has, of course, been selling off its stake, but remains a shareholder just below 10%. Their selling schedule should be terminated by now. They stated in the past that they intend to keep what they have left in JXN after the one-year period following the demerger as an investment.

Apollo Global Management, through its subsidiary Athene, also owns almost 10% of Jackson (although 11% or so in voting interest) due to an investment of $500 million in 2020, which would put the business value at $5 billion today. That means a third of the ownership interest is already split up between these three insider entities. The rest is mostly owned by big Wall Street firms and institutions, and a small fraction (below 5%) is owned by the general public. Overall, I believe this ownership structure bodes well. JXN is no favorite among retail investors and probably not even known by most market participants. That is why insiders own a large piece and the opportunity is reserved for a small, exclusive group.

Conclusion

In August 2022, Jim Cramer of CNBC (I know he’s a controversial figure, but he is a somewhat acclaimed investor) was asked about Jackson Financial on his show “Mad Money” and responded positively, claiming that “he liked that call,” JXN had “a nice yield,” and that “annuities are a good business.”

After having done my fair share of reading about the business and having conducted this analysis, I’m inclined to agree with him here. I will make the call that this is a rare opportunity, which should give investors a unique upside in the next years. All the circumstances add up to create severe mispricing. You have to do some digging, and you have to pick some valuation metrics to base your analysis on, which is not as easy here as it is with other companies. Net income volatility is high, and the market might never place the same emphasis on adjusted earnings (which are much more stable), even if it is appropriate in insurance.

But if it wasn’t messy, you wouldn’t have the opportunity. And, I would argue, you are so far off from any deserved level of valuation that you operate with a large enough margin of safety to sustain errors in your evaluation. Thus, the downside should be limited, and I think the risk/reward with this post spin-off opportunity is extremely favorable.

I’m incredibly excited to see where the market values JXN in two or three years when they have proven themselves as a separate, public entity. I believe JXN is a strong buy.