I was keen on the Prudential (LSE: PRU) share price earlier this year, as I reckoned the insurance giant’s planned demerger of M&G (LSE: MNG) could unlock value for investors. While I didn’t view M&G as an entirely unattractive business, I wrote that “I’d see the demerger as an opportunity to sell the shares in the spin-out company and retain shares in Prudential for the long term.”
The demerger completed two weeks ago, but I currently see merit in continuing to hold the M&G shares, at least for the foreseeable future. Indeed, I’d go so far as to rate the stock a ‘buy’ right now, along with its former parent Prudential. Here’s why.
Sum of the parts
When I was writing back in March, Prudential’s shares were trading at around 1,600p. I felt a sum-of-the-parts valuation of about 1,900p was reasonable, and I was looking for the demerger to unlock this value.
Investors who bought Prudential at 1,600p now own PRU shares, trading at 1,358p, and a matching number of free MNG shares, trading at 217p. This totals 1,575p. In other words, the combined value of the split businesses is around the same as when they were together, and the 1,900p I was looking for hasn’t been realised — yet. I still think it will be in due course.
M&G profile
As an asset manager and closed-book insurer in mature UK and European markets, M&G may not have the exciting growth potential of Asia-focused Prudential, but its cash flow profile, and ability to provide shareholders with generous dividends, is attractive for income seekers.
We have a situation where growth-biased investors who bought PRU now also hold MNG shares. Analysts expect a pretty much full recycling of MNG’s shareholder base over time, with income-seeking investors replacing the growth-biased holders.
Compelling value
I think the shareholder-base dynamic is depressing the share price at the moment. While M&G might have an unexciting growth outlook, I think the stock offers compelling value at the current level on an 18-month view.
My sums say investors can look forward to an 11.9p a share final dividend this year, along with a 3.85p special dividend. The 15.75p total gives a yield of 7.3%. I anticipate an 18.5p dividend in 2020 for a yield of 8.5%. These yields add up to an 18-month dividend return of near 16%.
I’m also anticipating a re-rating of the shares, as the churn of the shareholder base plays out. I can see M&G coming to trade with a peer-like 7% 2020 dividend yield, rather than the current 8.5%. This would see the share price rise to around 265p — representing 22% upside from today’s level. As such, I’ve pencilled in an 18-month total return (share price appreciation plus dividends) of 38% from M&G.
Long-term pick
Meanwhile, Prudential, my long-term pick of the two, also currently looks cheap. To realise my 1,900p total valuation of MNG and PRU, the latter’s share price would have to rise from its current 1,358p to 1,635p (20% upside). I’m also anticipating about 65p of dividends (4.8% yield) over the next 18 months, so a total return for the period of near 25%.
The 20% upside for PRU’s share price looks eminently reasonable to me. It would be trading at 11.2 times forecast 2020 earnings — still below its average historical multiple, and this for a company with a higher earnings growth outlook since the unyoking of M&G.
