Prudential Mid Year Review: Earnings & Investment Income In Focus

Prudential Financial‘s (NYSE:PRU) stock is down about 3% year-to-date (YTD) following mixed first and second quarter results. In the first half of 2016, the company’s revenues declined by 5% year-over-year (y-o-y) owing to a 8% decline in premiums earned, lower policy charges and fee income as well as lower income from asset management services. Total realized investment gains, reported as an adjustment figure in the financial results, declined by 48% y-o-y to $698 million in the first six months of the year.

The aforementioned factors resulted in the company’s post-tax adjusted operating income declining by about 31% y-o-y to $1.8 billion or $4.02 a share in the first half of 2016, much below consensus estimates.

Net Investment Income

The silver lining in Prudential’s financial results in the first half of 2016 was the 2% growth in its net investment income, even though its net investment income yield declined by 17 basis points to 3.65%. This was due to a slight decline in investment yield on both the fixed maturity securities as well as mortgage loans.

Prudential has considerable exposure to fixed maturity securities in the U.S., U.K as well as the rest of Europe. Post-Brexit, the yield on the 10-year U.S. treasury note fell below 1.5% for the first time since 2012, yields on U.K. benchmark government bonds fell below 1% for the first time on record and 10-year government bond yields in Germany ended below 0%. Other developed economies such as France, Sweden, Switzerland and Japan all touched all-time lows.

The fall in investment yields is likely to have a considerable impact on Prudential’s valuation, considering that investments contribute over 20% of the company’s valuation, per our estimates. We expect Prudential’s yield on U.S. retirement assets to decline to around 0.8% by the end of our forecast period. Owing to persistent low interest rates and falling government bond yields, there could be a downside of about 10% to the company’s valuation if its yield on U.S. retirement assets declines to about 0.7%.

Please refer to our complete analysis for Prudential Financial here.

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