Legal & General Group: We Share Management’s Confidence In Dividend Growth Story

Investment thesis

In our last article of 9 August 2022 on Legal & General Group Plc (OTCPK:LGGNY), we concluded that their projected earnings and dividend growth going forward for the next couple of years validated our stance of a Buy.

We are not alone in drawing such a conclusion. Over the last 11 months, there have been only Buy stances and even one Strong Buy.

Many economists have warned that the U.K.’s economy will go through a difficult time with what has been described as its longest recession since the GFC.

What could be the catalyst for the share price to go up?

Or should shareholders simply ignore this and just “clip coupons” through the 7.2% dividend yield?

Recently, insurance companies have changes to their accounting standards. Let us look at how this may affect LGGNY.

An introduction to IFRS 17

From the 1 st of January this year, the International Financial Reporting Standard’s IFRS 17 became effective. LGGNY will still use IFRS 4 when they report FY 2022 on the 8th of March 2023. Only when they report the FH 2023 results will the new IFRS 17 be used.

IFRS 17 is a new insurance accounting standard, replacing IFRS 4, that delays the timing of profit recognition so that profits materialize gradually over the duration of the insurance contract.

How will this impact LGGNY?

It does not change their ability to generate cash and capital. It merely changes the timing of when they can recognize their insurance earnings. It is similar to what happened in the maritime industry where they in the past would state earnings taking into account a period when a ship has zero earnings. Ships have what we call a laden leg, with cargo onboard, and a ballast leg, where it has to reposition the next money-earning voyage.

These changes will actually give some fluctuations quarter to quarter but over a longer period should make no difference.

Areas that will be affected by these accounting changes are their pension risk transfer, retail individual annuities, and their life insurance in the U.K. and the U.S. That makes up approximately 65% of their operational profit.

It changes nothing for the other business activities such as savings and mortgages and their asset creation and asset management, which make for the other 35% of their operational profit.

Shareholder-friendly capital return policy

Since the GFC of 2008, LGGNY has been a good dividend growth company.

We are investing for the future, so we need to assess whether it is a good chance that they can continue to grow the dividend going forward.

Management had earlier set a goal to grow the dividend between 3 and 6% per annum between 2020 and 2024. They are now quite confident that they can grow the dividend by 5% per annum up to 2024. From there on it is harder to project.

How safe is this dividend?

It is well covered as they are still on course to generate a cumulative net surplus of cash over the dividend of GBP 500 million in the period of 2020 to 2022.

Risks to the thesis

When LGGNY takes over pension liabilities from companies they sign up for a liability which is referred to as the underwriting risks.

In the annuity business, they are required to pay out a pension until the person dies. The risk is that people live longer than they have estimated. It is not like a “black swan” event. They know that the risk is there and has 187 years’ worth of experience in assessing this risk. Nevertheless, it is still a risk.

The solvency rate is our way of looking at their financial ability to meet their future liabilities. Their solvency position is currently estimated to be in the range of 220-225%.

On the topic of black swan events, that could be something similar to what we saw at the end of September last year when the Bank of England intervened in the market for guilds following a sharp rise in yields that caused the value of the bonds to drop sharply.

Conclusion

It is hard not to like LGGNY.

Their records of increasing the dividend and a good yield north of 7% attract us and many other investors.

However, the share price over a period of the last 10 years has been trading in a range between $15 and $20.

It seems hard for it to break out and go higher.

We maintain our Buy stance at the present share price.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.