It’s been three months since I last visited Principal Financial Group (
(Source: Company website)
The recent market volatility has posed a challenge to PFG, since it generates fees based on AUM. However, I see the recent weakness as being an overreaction. As seen below, since the start of September, PFG’s share price has declined by 8.9%, while the S&P 500 declined by just 2.4%. Plus, this is on top of the declines that PFG has seen on a YTD basis, with a 29.4% drop since the beginning of the year, while the S&P 500 has posted a 2.6% gain.
(Source: Yahoo Finance)
COVID-19 impacted the company’s latest quarter’s results, as non-GAAP earnings per diluted share decreased by 6% YoY. This was driven by lower RIS (Retirement and Income Solutions) sales and lower interest rates. In addition, roughly 2% of plan participants had taken COVID-related hardship withdrawals last quarter.
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This was partially offset by better client retention rates, and a $68M net benefit from favorable dental/vision and disability claims, due to decreased doctor’s office visits and lower consumer mobility. However, management expects increased dental/vision utilization to be a headwind in the second half of this year.
While low interest rates will continue to pose a headwind through at least 2023, I see this as already being reflected in the share price. In addition, the Fed Chairman has expressed his unwillingness to take the benchmark rate below zero, so I don’t see added risk on the horizon. Also, I expect the drop in RIS sales to be temporary, as management noted that many RIS sales could be pushed into 2021.
In addition, PFG has a largely variable cost structure, and management has tended to align costs with revenues. This is supported by management’s note on the last conference call:
“Compared to our expectations at the beginning of the year, we reduced expenses by approximately $75 million in the second quarter alone. This has spread across all businesses and contributing to resilient margins despite revenue pressures. Some of the expenses are naturally lower right now, like travel, sales related expenses and bonus accruals. And we’ve intentionally reduced other expenses, including hiring, salary cost, third-Party spend as well as marketing and advertising. These actions will continue to impact earnings and margins the rest of the year.”
In the meantime, the firm appears to be doing well in terms of drawing new investment capital. AUM increased by $71B during the last quarter, of which $67B was related to market performance. This implies that the remaining $4B was related to net investment inflows. I find this to be encouraging, especially considering the currently down economic environment.
I also like the fact that PFG has relatively low exposure to the higher risk sectors of Food Services, Retail, and Entertainment, and relatively higher exposure to industries that are more immune to the pandemic, as seen below.
(Source: Company Earnings Presentation)
Balance Sheet Strength
In the meantime, the company is operating from a position of financial strength. As seen below, PFG has $3B worth of liquidity, with a debt-to-capital ratio of 23.5%. Its RBC (risk-based capital) ratio of 422% is above its targeted range of 400%, and is well above the 250% required by the NAIC (National Association of Insurance Commissioners).
(Source: Company Earnings Presentation)
Based on the analyst estimates below, PFG is expected to post an average 5.4% annual growth over the next three years.
With this in mind, I wanted to calculate what the PEG ratio is, with the following inputs:
- Price: $38.82
- EPS: $5.40 (2020 EPS Estimate)
- EPS Growth Rate: 5.4 (based on average of 2020-2022 growth rates)
With the inputs above, I arrive at a PEG ratio of 1.33. Using a PEG ratio of 2 as a standard for fair value, the shares appear to be undervalued with a potential 50% upside (2/1.33 -1). Analysts seem to share a favorable opinion of the stock, an average price target of $47.80. If we were to use the more conservative analyst price target, the shares appear to have a 23% upside potential from the current valuation. In addition, I also find the 5.8% dividend yield to be attractive, with a dividend to earnings payout ratio of 41.5%, and a 5-year dividend CAGR of 11.2%.
Principal Financial Group is a diversified financial services company that provides retirement plans and insurance. COVID-19 has presented some challenges, such as decreased RIS sales and increased COVID-related hardship withdrawals. However, I see these risks as being temporary, with the expectation that sales will pick up in 2021. In the meantime, management has committed to reducing its variable expenses, and the balance sheet appears to be strong, with ample liquidity and an A- credit rating.
The shares appear to be undervalued at the current price of $38.82 and a blended P/E ratio of 7.2, which sits well below the normal P/E of 11.3. In addition, the valuation exercise also showed that the shares are undervalued from a forward growth perspective. If we were to use the more conservative analysts’ average price target, the shares appear to have a 23% upside from the current price. This is in addition to the 5.8% dividend yield, which I view as safe. As such, I have a favorable view of the stock and see further upside potential.
(Source: F.A.S.T. Graphs)
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article is for informational purposes and does not constitute as financial advice. Readers are encouraged and expected to perform their own due diligence prior to making any investment decisions.