JUST too cheap to pass up

I passed the June 2018 CFA Level 2 Exam! And that is no guarantee when it comes to investment performance, but the knowledge acquired will (I hope) prove to be useful when analysing companies to invest in.

Due to my (perhaps misguided) increase in confidence, I decided it was time to invest more of my savings, also because I had been following developments with Just Group PLC and thought the time was right, with its share price dropping from around 140p in June to around 90p at the beginning of September (a 36% drop), after being at 170p at the beginning of the year (close to a 50% drop, and I’m a sucker for bargains).

On August 25 I contributed another £1,500 to my ISA and watched JUST keep falling. On September 3, after reading its previous trading statement and annual report, and only three days before JUST published their new trading statement, I decided the price was right and bought 1,650 shares at 88.96p paying £1,467.91, a dealing charge of £9.95, and stamp duty of £7.34, for a total cost of £1,485.20.

just contract note

On September 6 JUST published its trading update and the share price finished the day up 2%, at 88p, but proceeded to fall the following days. When it reached 70p on September 19, I decided to contribute £1,500 more and buy an additional 2,150 shares for a total investment of £1,520.10.

Just contract note 2

I now own 3,800 shares of JUST at a total cost of £3,005.30, making my average price 79p. Since the share price closed at 88.40p last Friday, I now have a profit of £353.90 (an 11.78% return on my investment in less than a month).

So why has its share price been falling? Let’s get to know the company a bit…

Profile

Per its FT profile, Just Group PLC is a Reigate, Surrey based financial services company that operates three segments: insurance, which writes insurance products for the retirement market (guaranteed income for life solutions, defined benefit de-risking solutions, care plans, and drawdown contracts) and invests the premiums received in corporate bonds, lifetime mortgage advances, and other financial investments; other segments, such as regulated advice and intermediary services, and professional services to corporates; and corporate activities, which are involved in managing its liquidity, capital and investment activities.

As of Friday, September 28, JUST had a market cap of £829.69m, a dividend yield of 4.21%, and a PE ratio of 5.75 (yum!). The reason it’s been falling so much is that, in July,  the PRA announced a review into providers holding lifetime mortgages to back annuities, and the company believes this will reduce its regulatory capital position by £160m. This would wipe out 10% off its Solvency II ratio, which stood at 140% at the end of 2017. And investors are panicking due to the uncertainty this review is causing.

2017 Annual Report

JUST’s 2017 annual report provides a bit more clarity into their activities. The company serves four different groups:

  • Trustees and scheme sponsors, providing member security and de-risking pension liabilities (£600 billion market);
  • Individuals, providing retirement income (£1 trillion market);
  • Homeowners, for people aged 60+ who want to access their property wealth (£2.5 trillion market);
  • Corporate clients, developing scalable retirement-focused solutions for banks, building societies, life assurance companies, pension scheme trustees, etc;

through several solutions and services:

  • Defined benefit de-risking solutions (DB), for pension scheme trustees that want to reduce their financial risks and make sure their members’ pensions will be paid in the future;
  • Guaranteed income for life (GIfL), for people who want to be certain they will receive a guaranteed income for life;
  • Flexible pension plan (FPP), for people who want to retain some flexibility and make irregular withdrawals from their pension savings;
  • Care plans, for people moving into residential care who want a regular payment to be made to the care provider for the rest of their life;
  • Lifetime mortgages (LTM), for people who want to release some of their home’s value (a form of equity release with capital and interest payable upon death or when the mortgage holder moves into residential care);
  • Hub financial solutions (HUB), a regulated financial advice service that supports individuals and organisations with their retirement needs.

Pros

  1. I love their slogan: “We help people achieve a better later life“. Simple, to the point, explains the purpose of this company and how they can benefit their clients (page 1);
  2. Full year dividend of 3.72p, a 6% increase over the previous year dividend and a 4.2% yield over the current share price of 88.40p (page 3);
  3. Adjusted operating profit before tax of £220.6m, up 35% from £163.7m in 2016 (page 3);
  4. IFRS profit before tax of £181.3m, an increase of 5% compared to 2016 (page 14);
  5. IFRS new business margin of 9%, up from 6.8% in 2016 and 3.3% in 2015 (page 15);
  6. Merger synergy benefits between Just Retirement Group PLC and Partnership Assurance Group PLC of £52m, in excess of their original £40m target (page 14);
  7. Economic capital ratio (available capital as a percentage of required capital) of 238%, up from 216% in 2016 (page 15);
  8. 2017 adjusted earnings per share of 19.15p, up 36% from 14.07p in 2016 (page 28);
  9. Own funds of £2,269m, up from £2,100 in 2016, and £663m in excess of solvency capital requirements (SCR is the risk capital required to be set aside to absorb stress tests of each risk the Group is exposed to, such as longevity risk, property risk, credit risk, and interest rate risk) (page 28);
  10. Total financial investments of £18,287.1m (52% in debt instruments and other fixed income securities, 37% in loans secured by residential mortgages, about 14% in others), up 5.6% from £17.319.6m in 2016 (page 33);
  11. 61% of the company’s corporate bond and gilts portfolio is rated A or above (page 34);
  12. The mortgage portfolio’s loan-to-value ratio stood at 29% at yearend 2017 (very conservative) (page 34);
  13. Total equity of £1,740.5m, up £129.9m from £1,610.6m at yearend 2016, reflecting profit after tax of £155.1m, dividends paid of £33.2m and shares issued for incentive schemes (page 34);
  14. HUB customer transactions have increased 146% since 2015 to reach £426m in 2017 (page 36);
  15. Share price increased 14% to 170.4p during 2017 (page 45);
  16. Net cash inflow from operating activities of £587.5m (71% of the company’s current market cap), compared to a cash outflow of £188.4m in 2016 (page 90);
  17. Cash and cash equivalents of £1,159.3m, £515.6m more than at yearend 2016 (page 90);
  18. Acquisition of 100% of Partnership Assurance Group PLC on an all share exchange giving PAG shareholders 0.834 shares of Just Retirement Group for each PAG share held, making them the holders of about 40% of the combined group. At the closing price of 154.6p on 1 April 2016, this represented an acquisition price of £569.5m (69% of current market cap) (page 98).

Cons

  1. 140 pages long…;
  2. Solvency ratio of 141% at yearend 2017, down from 151% in 2016 (page 15);
  3. This is only the first full year of results after Just Retirement merged with Partnership Assurance to form Just Group PLC in April 2016, so not a long performance history (page 16);
  4. New business sales for care plans down 26% to £71.6m (page 27);
  5. Lifetime Mortgage loans advanced down 9% to £510m (page 27);
  6. Investment and economic profits of £22.6m, down from £93.1m in 2016, mainly due to narrowing credit spreads and positive corporate bond default experience (page 32);
  7. Rodney Cook, the CEO, was paid £2,369m last year in total, which seems a bit excessive for a company worth less than £1b (page 59);
  8. As with any insurance company, valuing their own insurance liabilities involves significant judgement over uncertain future outcomes, such as the total final settlement value of long-term policyholder liabilities. It also needs to use judgement in selecting key operating (mortality, expected level of future expenses) and economic (credit risk) assumptions. All this to say that valuation is subjective, and therefore risky (page 82);
  9. Valuation of its loans secured by residential mortgages, reinsurance assets and deposits received from insurers, and investments made in subsidiaries, is also subjective (pages 83,84);
  10. No equity investments whatsoever in its investment portfolio, meaning the company is extremely conservative, and could be making a better return on its money (page 109).

18 Pros and 10 Cons! Nice…

2018 Interim Results

JUST published the interim results for the 6 months ended 30 June 2018 on September 6:

Pros

  1. Adjusted operating profit up 85% to £124m in H1 2018 compared £67m in the same period last year (page 1);
  2. New business profit up 88% to £121m compared to H1 2017, driven by strong sales growth and an increase in new business margin (page 1);
  3. Retirement income sales growth of 64% with Defined Benefit Re-Risking (DB) sales up 143% and Guaranteed Income for Life (GIfL) up 9% (page 1);
  4. Embedded value per share of 230p and IFRS Tangible Net Asset Value of 169p (which compares very favorably to the current 88.40p price) (page 1);
  5. Solvency coverage ratio of 150%; 142% after allowance for notional TMTP (transitional measures for technical provisions) recalculation (page 1);
  6. Advanced £312.7m of Lifetime Mortgage (LTM) loans compared to £230.2 year-on-year, a 26% rise (page 4);
  7.  The company remains comfortable investing in a mixture of gilts, corporate bonds, mortgages, private placement and infrastructure loans to back their DB and GIfL liabilities (page 4);
  8. Its Lifetime Mortgage portfolio has an average loan-to-value of only 31% (page 4);
  9. The company has a £200m revolving credit facility that remains undrawn and available to support the business (page 5);
  10. IFRS net assets of £1,768.3m and European embedded value (sum of shareholder’s net assets and the value of in-force business) of £2,159.8m, 113% and 160% above its current market cap, respectively (page 7);
  11. Adjusted EPS of 10.81p compared to 5.83p in H1 2017 (page 10);
  12. Own funds of £2,271m, up more than 6% yoy and 42% higher than the solvency capital requirement of £1,600m (page 10);
  13. Cash and cash equivalents available at June 30 of £1,095m (page 31);
  14. Total investments of £19,050.3m, up 4.2% from £18,287.1m at yearend 2017 (page 38);
  15. Total loans of £573.3m (conservative considering the company has £1,768.3m in equity) (page 48).

Cons

  1. IFRS profit before tax of £45.7m, down 31% from £66m last year, mainly due to negative economic variances due to increased interest rates compared to the prior period (by this they mean that some of their investments decreased in market value due to the BoE raising interest rates, which does not imply a money out flow but only a paper loss, since the company will recover its initial investment in full if these are held to maturity, while still receiving the interest and dividends they provide. The company must still report any decrease in market value anyway) (page 1);
  2. The interim dividend was deferred due to the uncertainty created by Consultation Paper 13/18 (PRA’s review into providers holding lifetime mortgages to back annuities) (page 1);
  3. Raised £230m in Tier 3 capital in February (this may strengthen their capital position, but it’s still debt) (page 5);
  4. Investment and economic losses of £58.7m compared to a profit of £31m last year, mainly due to an increase in risk free rates and widening credit spreads (page 13).

15 Pros and only 4 Cons! What a great semester…

Conclusion

I really like this company. I think they have their heart in the right place, and really place customers first while combining this with a strong shareholder orientation.

Recent operating performance has been excellent and, as I said before, I think the fall in share price has more to do with investors panicking and reacting emotionally to PRA’s consultation paper than to the fall in statutory profits. I don’t believe this is such a major concern since JUST is conservative to a fault (as seen by the lack of equity investments in its portfolio) and should easily be able to weather changes in regulatory legislation.

This was a very easy decision, and JUST went straight into my ‘Yes’ tray. Besides becoming an investor, I might also become a client in the future.

Valuation

The merger between JUST and Partnership is very recent, so I don’t have a long performance track record to check average yearly earnings for the last 5 years and decide what would be an appropriate multiple to pay for those.

One conservative estimate of company value, which is somewhat suitable for insurance companies, is their book value (meaning equity or net assets). IFRS net assets at H1 2018 was £1,768.3m. Since the company has 944.4 million diluted shares outstanding, this gives me a value of 187.24p per share (£1,768.3m/944.4m), more than double its current price of 88.4p (111.8% more, to be exact).

Hence why I was comfortable buying at about 90p, and then buying even more at 70p. I think these prices are ridiculously cheap.

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