What Lies Ahead For Prudential After Upbeat Q2 Performance?

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Prudential Financial

Prudential Financial (NYSE:PRU) recently reported earnings for the second quarter of 2015 ahead of market estimates. Buoyed by an increase in premium volumes, new business growth in Asian markets as well as new deals in the retirement solutions business, Prudential saw upbeat operating earnings during the second quarter. [1] However, two factors that have plagued Prudential’s performance over the past few quarters – low investment income and foreign currency fluctuations – remain key challenges for the company despite improving business growth. In this note, we discuss key takeaways from Prudential’s performance in the second quarter and the factors that will affect growth going forward.

We have a price estimate of $91 for Prudential’s stock, which is in line with the current market price.

See our Complete Analysis of Prudential here

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Business Growth Continues

Prudential’s second quarter earnings were boosted by higher sales, positive market impacts, favorable claims-related experience and new business deals, which helped lift its operating income by 8% year-over-year to about $1.2 billion (excluding the impact of actuarial reviews and changes to reserves). [2] One area in which the company has continued to show improvement is pension fund risk transfers in the Retirement Solutions division. During the second quarter, Prudential added four new pension risk transfer deals worth $5.7 billion. This is a high potential market for Prudential; according to a research report by Mercer, as of July there was an aggregate deficit of $379 billion in the funding level of pension funds sponsored by S&P 1500 companies. This has more than doubled in the past twelve months. [3] We expect Prudential to take advantage of this opportunity in the market over the coming quarters. By the end of our forecast period, we expect Prudential’s operating income from the U.S. Retirement Solutions division to nearly double and cross $6 billion.

Despite Business Growth, Challenges Remain

Although Prudential is experiencing healthy business growth and has bounced back from net losses in 2013, investment income and its impact on operating margins will be key. Investment income has been under pressure for a long time. The majority of the company’s investments (nearly 75%) are held in fixed maturity securities, and the persistent low interest rate environment has suppressed yields. During the first six months of 2015, Prudential’s net investment income has been around $7.4 billion compared to nearly $7.6 billion in 2014, and this has also put pressure on margins. Going forward, we anticipate a gradual rise in interest rates. Accordingly, we expect Prudential’s yield on investments to witness improvements and reach pre-crisis levels by the end of our forecast period. Subsequently, pressure on Prudential’s operating margins will also ease.

Q2 2015 Earnings Recap:

  • 22% y-o-y rise in net income of $1.4 billion;
  • Basic EPS of $3.07, up from $2.26 a year ago;
  • After-tax operating income of $1.35 billion, compared to about $1.2billion a year ago [4]

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Notes:
  1. Prudential Financial John Robert Strangfeld on Q2 2015 Results, Seeking Alpha []
  2. Prudential Financial, Inc. Announces Second Quarter 2015 Results []
  3. S&P 1500 Pension Funded Status Drops 1% in July as Decreasing Rates Overpower Effect of Increasing Equity Markets, Mercer Press Release []
  4. SEC 10Q Filing []