Jackson Financial Stock: The undervalued market leader

investment thesis

After last year’s spin-off from Prudential (PRU), Jackson Financial (New York Stock Exchange:JXN) It is actively expanding its name recognition among investors as it continues to strive to broaden its shareholder base to enhance its valuation. Although his company graph Spanning just 14 months, the company has been in operation for more than 60 years, in part as a division of PRU, during which time it has become the industry leader in the pension market, thanks to its unparalleled distribution network of knowledgeable independent financial advisors. Brand.

Due to this newness as a standalone company, relatively small market capitalization, lack of coverage, and influx of news, the company remains unfollowed. However, the quality of governance, market leading position and risk approach remain unchanged. These factors combined to create an attractive investment opportunity at a low price that will turn into double-digit gains when the stock market becomes familiar with the Jackson name.

Our Buy Recommendation reflects JXN’s leading position in the fixed annuity market and its large market share for variable annuities, supported by strong distribution and market channels supported by a robust back office infrastructure.

revenue trends

The majority of JXN’s profits come from management fees associated with its annual products. This item has remained relatively stable over the years, with slight fluctuations due to changes in the average value of annuity accounts, which have arisen mainly due to changes in interest rates. JXN has to invest heavily in debt instruments to pay annuity obligations, the value of which is sensitive to changes in interest rates. However, volatility in bond prices is, on average, less predictable than movements in stock markets, and this consistency helps mitigate the large volatility in JXN’s fee income.

JXN needs to maintain the large derivatives holdings necessary to maintain its capital base while meeting consumer needs with a higher tolerance for risk. These derivatives allow JXN to offer annuities with varying risk characteristics (including exposure to equity), increase its product offering and attract new consumers.

Changes in the fair value of these derivatives are recorded in the revenue line, which supports last year’s revenue volatility picture when stock markets retreated from their previous year’s highs. Despite the upside and downside fluctuations in hedging instruments, the impact on cash flow is limited.

The chart below shows JXN’s revenue by segment, showing relatively flat fee income and a more volatile net gain on derivatives driven by last year’s market sell-off.

balance sheet

As a safety measure against losses, financial institutions are required to keep a certain amount of cash and other quality assets on hand. These liquidity requirements vary according to the type of institution and the nature of its work. With the current market turmoil in mind, management is confident that the Company has sufficient cash to meet regulatory capital and liquidity requirements. Most of JXN’s assets are mainly invested in high-quality corporate bonds, government securities and mortgage-backed securities, enhancing risk-based capital coverage. Most of its liabilities are contractual obligations towards its policyholders and beneficiaries.

In recent quarters, we have witnessed a decline in stock and bond prices, which put pressure on the balance sheets of financial institutions, including JXN, whose capital was affected by unrealized capital losses, offsetting the gains of the hedge.

Although higher interest rates negatively affect GAAP earnings in the short term through higher unrealized losses, higher rates are expected to have a positive effect in the long term by increasing interest income on debt investments. Higher interest rates also increase the attractiveness of annuity products. So far, we see a limited impact on the company’s operating cash flows, as losses remain limited to non-cash fair value measurements.

Dividends and valuation

Dividends and buybacks show that management is confident in its ability to preserve its capital while providing good returns to shareholders. However, the rating agencies were concerned that management’s obligation to return funds to investors might hinder its ability to maintain adequate capital reserves in the event of something unforeseen, for example, an unexpected adverse event affecting liquidity. Every financial institution has to walk this fine line, and the way management returns capital to investors is not troubling at all. Stock buybacks and dividends are only a fraction of a company’s operating cash flows, as shown in the table below.

Thus, the dividend yield of 6% is not because the company pays out too much money but because the stock is undervalued. The forward non-GAAP price-to-earnings ratio (adjusted for non-cash derivative write-downs) is currently 2.3%, 77% below the industry average. The company’s current market value is a fraction of its tangible book value. Stocks are so undervalued that small share repurchase budgets make all the difference in the number of shares. Since going public, the company has purchased 12.5% ​​of all outstanding shares, using just $500 million. In fact, last year the company made enough cash to buy back all of its shares. I think this underpricing of the market will sustain double-digit growth for years to come.

summary

JXN celebrated its first year as an independent company last September. However, its legacy dates back to the 1960s before it was acquired by Prudential, where it thrived as a market leader in the annual underwriting space. This allowed JXN to start operating without any disruption to its insurance business or operations, and no restarts of old insurance policies despite market disruptions. The dividend and share buyback is just a continuation of the governance policy in place when it was a backing of Prudential.

The high return is not the result of a higher payout ratio but rather an undervalued stock. As JXN builds its name as a standalone company, I expect capital gains over the next 2-3 years with its strong underlying growth and increased dividend payout.