Prudential Earnings Preview: FX Headwinds, Investment Income In Focus

Prudential Financial (NYSE:PRU) is scheduled to report earnings for the fourth quarter of 2014 on Wednesday, February 4. ^[1] As exhibited by Prudential’s performance during the first nine months of 2014, it was a turnaround period for the company. The company reported net income of $2.8 billion for the three quarter period in 2014, compared to a net loss of $667 million reported for 2013. The company’s top line also improved, as revenues jumped 21% year-over-year (y-o-y) to about $38 billion. However, during the third quarter, the combined effect of net realized losses on investments and FX headwinds resulted in a weak performance. The company’s net income fell from $966 million in the third quarter of 2013 to $465 million in 2014. On the back of the weak performance, the company’s stock has dropped by more than 10% since November.

We expect FX headwinds to impact the company’s earnings for the fourth quarter as well. Also in focus will be the persistent low interest rate environment and uncertain economic environments in several international regions. In this note we take a look at key trends that are likely to have a bearing on Prudential’s performance in Q4.

We have a price estimate of $102 for Prudential’s stock, which is about 30% higher than the current market price.

See our Complete Analysis of Prudential here

International Operations – FX Headwinds Loom Large

Operating in countries including Japan, Taiwan, Italy, Korea, Brazil, Argentina, Poland and Mexico, Prudential earns nearly one-third of its operating income from outside the U.S. Of these, Life Planner and Gibraltar Life in Japan form the major chunk of income and revenues for the company. FX headwinds adversely impacted the company’s earnings during the last quarter. We expect it will continue to be a dampening factor for the company during the last quarter of 2014 as well. The Japanese Yen has continued to decline through the last few quarters, reaching a six year low. It will be interesting to find out the company’s success with hedging strategies particularly against the Yen to offset its negative impact on earnings.

What’s Driving The U.S. Operations?

Prudential is the third largest life insurer in the U.S. with over a 5% market share in terms of premiums earned. ^[2] Lower operating margins in the individual life business and a loss from the group insurance line hit Prudential’s operating income from the life insurance business during the three quarters of 2014, resulting in a 30% decline. Prudential reported a decrease in individual life insurance sales based on new business premiums from $165 million in the third quarter of 2013 to $97 million in 2014, largely due to a $61 million decline in sales of guaranteed universal life insurance products.  The number of individual life insurance policies across the U.S. declined by about 3% through September 2014. Individual life insurance premiums across the U.S. declined 1% during the same period, with a 26% increase in variable universal life insurance policy premiums, a 8% decline in universal life and 2% in term life insurance premiums.  ((LIMRA’s U.S. Individual Life Insurance Sales Summary Report, Third Quarter 2014))

Prudential’s U.S. retirement solutions division offers individual annuities, retirement and asset management solutions. The company’s total assets grew by about 4% y-o-y in the first three quarters of 2014. A drop in income from the individual annuities product line, in line with an industry wide trend, overshadowed positive growth in income from the asset management and retirement product lines, resulting in a 7% y-o-y drop in operating income from the division.

Investment Income In Focus

Income from investments is a crucial component of Prudential’s earnings. The company maintains an investment portfolio consisting of instruments such as fixed maturity securities, commercial mortgage loans and equities. In the U.S., the low interest rate environment has lasted for a long period of time, as indicated by the low rates of the 10 year Treasury yields. ^[3] A similar environment has prevailed in Japan and much of Europe, where economic performance has been slack. We expect this to weigh on the investment income for the company during the fourth quarter results. Going forward, we expect this situation to continue in the upcoming quarters.

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More Trefis Research

1. Q4 2014 Prudential Financial, Inc. Earnings Release, Events Calendar, Investor Relations [↩]
2. NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS LIFE AND FRATERNAL INSURANCE INDUSTRY 2013 TOP 25 GROUPS AND COMPANIES BY COUNTRYWIDE PREMIUM [↩]
3. Daily Treasury Yield Curve Rates, U.S. Department of the Treasury [↩]