Legal & General Stock: Attractive ROE Will Lead To Appreciation Over Time (OTCMKTS:LGGNF)

After our recent update on Aviva (AIVAF, OTCPK:AVVIY), today we move on with another UK entity called Legal & General Group Plc (LGGNF, OTCPK:LGGNY). The company engages in its activity through four divisions:

1. Legal & General Retirement,
2. Legal & General Investment Management,
3. Legal & General Capital,
4. Legal & General Insurance.

With over a trillion pounds of AuM (£1.4 trillion to be precise), L&G is one of the biggest investment management companies across Europe. Their business is not focused only in the UK but also in the USA, and internationally. Legal & General Group used to be an insurance company but currently, most of the top-line revenue is coming from its Investment Management arm. The deal to sell its insurance business was first announced in 2019, and in 2020 the Group sold the remaining part of the L&G general insurance business to Allianz.

There are 3 key reasons as to why we prefer Legal & General over Aviva:

1. The positive growth trend in dividends, with an attractive yield;
2. The advantage in ROE due to segment diversification and synergies;
3. Highly synergic Asset Management business that allows them to reinvest in highly attractive Alternative asset classes, including Real Estate.

Now someone might think that due to the important yield the Company has seen stagnation in their performance. This is not the case. L&G is a well-managed company with a strong profitability path over the years.

Going back to the comps analysis, we note the following:

1. L&G had a more stable P/E ratio over the years thanks to the business mix compared to Aviva;
2. Higher dividend yield in the last three years and no suspension of payment for the COVID-19 pandemic.

Here below, thanks to TIKR we can see the DPS evolution from 2011 to 2020.

regarding the ROE evolution over time, the different sector mix is key for the overperformance of Legal & General compared to Aviva.

From a net income perspective, the argument for stability still holds, with L&G averaging £1.85 billion over the time frame considered. This creates, in our opinion, the number one condition to sustain the planned dividend growth. The reason for stability is further enhanced by the client retention, which according to management usually spans at least 40 years and spills over to the other asset management segments which have an average life of 15 years.

As already mentioned Aviva is an insurance pure player with higher SRII requirements, whereas L&G mainly focuses its activities on asset management. Please see below the latest AuM in billion pounds.

From a segment perspective, this difference in sources of income is the main reason for differing returns. The biggest elements which make up Legal & General’s operating profit are:

1. The institutional retirement solution that is essentially their internal cash cow;
2. Followed by the retail retirement segment;
3. The asset management arm which is deeply synergic with their own retirement solution, the very attractive LGC asset origination, which deals in alternative assets which comprise of infrastructures in clean energy, private credit, and commercial real estate;
4. LGI divided between the UK and the US are the life insurance and the residual contributors.

Conclusion and main Risks

With very consistent prospects, we value the company with a DCF model to capture the medium & long-term growth story. By using L&G’s investment in the Pension Risk Transfer and future cash flows prediction, our internal team used the L&G capital generation and came up with a value of £3.5 per share, versus the current market price of £2.7 per share. On a final note, the generous & stable dividend offered by the company is currently yielding more than 7% at the time of writing.

Main risks to our target price:

1. Weak macro developments;
2. Investment market risk, in particular the credit risk
3. Regulation after the Brexit