Monday, December 05, 2005

Prudential - Running out of steam?

  
The insurance giant's stock has been on a tear this year, but it'll be tough to keep it going

By Shaheen Pasha, CNNMoney.com staff writer, December 5, 2005: 12:39 PM EST

New York(CNNMoney.com) - You can call Prudential Financial the comeback kid.

At the end of 2001, when other companies were shying away from the initial public offering market in the wake of the Sept. 11 terrorist attacks, struggling Newark, N.J.-based Prudential shrugged off its mutual corporate structure -- in which policy holders own the company and have a stake in its gains and losses. Instead, it emerged as a public company. At the time, it was earning just 4 percent above its net assets, hardly stellar for a measure known as return on equity.

But through the success of some well-timed acquisitions, and consistent growth in its retirement, annuities and international businesses, Prudential has emerged as a force to be reckoned with in the insurance industry.

Investors rewarded the company for its tenacity. In the last year alone, Prudential's stock price soared over 40 percent. As the year comes to a close, Prudential is touting a healthy $3.5 billion in excess capital. And the company plans to deliver on its promise of achieving a 12 percent return on equity by the end of 2005 -- giving analysts some reason to cheer.

But given Prudential's stellar run, is there room left for investors late to the game?

Analysts say don't bet on it.

"Prudential had a fantastic year, but it's hard to be optimistic about 2006," said Dafina Dunmore, equity analyst at Morningstar Inc. "The company had a lot of one-time events that bolstered its earnings, such as prepayment income from its mortgages."

But higher interest rates and expectations that consumers will slow down refinancing activity should put a crimp in that line of business. The company also benefited from unusually strong investment results in 2005, which may slow down next year, as well as a one-time reduction in tax reserves.

From a valuation perspective, the company's stock is trading above fair value at $69 a share, she said.

While the stock may have gotten ahead of itself in 2005, Dunmore, who currently has a "hold" rating on the company, said Prudential is still a promising investment for those with a long-term perspective.

And one factor that could make Prudential more attractive in the near-term is the possibility it will make an acquisition, analysts said.

Rob Haines, insurance analyst at Credit Sights, said the life insurance industry is ripe for acquisition -- and with a hefty amount of excess capital on hand, Prudential is in a particularly sweet spot to buy.

"The life insurance industry is facing a more competitive environment because banks are edging in on their traditional products and there is so much excess capacity," he said. "It makes sense at this point of time to try to generate scale through acquisitions to generate the growth that justifies the stock price."

In a research note in November, Citigroup analyst Colin Devine raised the possibility that Prudential may be interested in buying Philadelphia-based Lincoln National Corp. (Research) in order to acquire its variable annuity distribution platform as well as its Delaware Investment Management unit.

But Credit Sight's Haines dismissed the speculation, saying that a deal with Lincoln National – which announced a $7.5 billion acquisition of Jefferson-Pilot in October – would have too much execution risk and would likely prove to be a logistical nightmare from an integration standpoint.

A small-to-midsized acquisition, however, could bolster the company's scale without too much execution risk, he said, adding that Prudential's acquisitions of Cigna's retirement business and American Skandia, which specializes in variable annuities, have already proven to be a driver of profits.

A good track record with prior buys could go a long way with investors, Haines added.

But Vanessa Wilson, equity research analyst at Deutsche Bank, said the company doesn't need any acquisitions to grow next year. After a recent meeting with Prudential executives, Wilson said she expects the company to continue to grow its return on equity between 12 percent and 14 percent over the long term.

She said the company has a strong asset management business and should continue to see particularly strong growth in its international business, as Asia becomes a hotter market for asset management and insurance.

Wilson didn't rule out the possibility that the company will make strategic acquisitions in the future given its strong excess capital base. And she said opportunistic acquisitions in the international business and retirement segment would be particularly attractive. If the company makes accretive buys in the short term, it could boost her rating on the stock from the current "hold."

But for now, Wilson expects investors to face some limited downside on the stock price, with a price target of $75.

None of the analysts quoted in the story own shares of Prudential. But Deutsche Bank has an investment banking relationship with the company.
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