Despite mainly investing in "growth" stocks, or rather stocks which are a mix of growth/modest income characteristics, I have one or two holdings in stocks which I think fit the "reach for yield" criteria. One of those is Legal and General (LGEN), which constitutes about 3.2% of our total market value. I notice that currently it's yield is rather tantalising. However, is it's dividend and SP safe? Being interested in analysing, well at least attempting to, the financial statements in company Annual Reports I decided to have a dig into LGEN's, and also to root around the internet looking for any gossip.
As some will suspect, the format of LGEN's statements and the nature of their business, makes the figures from this firm very difficult to represent in the "standard company analysis" spreadsheet which I usually like to use, for example their "revenue" figure is not the actual top line of their P&L and worse still, the figure to which they refer to as "Total revenue" becomes "Total income" in the period from 2014-2019. Furthermore LGEN's notion of Operating income seems to be a figure that comes before the total revenue/income. Subsequently I choose to fabricate my own version of their EBIT (operating income/profit to many) by adding back finance costs to PBT. (This may be entirely the wrong approach). Additionally, LGEN's CF statement, especially the "flows due to operations" section, seems to vary a lot from many other presentations: I notice that  some entries I usually associate with financing flows, and  an entry usually comprising a "from investing" flow also appears in Cash from Operations section.
So I decided to take a new blank sheet and just add any particular significant datas from the past six years worth of ARs, and see what conclusions jumped out at me.
So as we can see the (sort of) top line i.e. "Total Revenue" or what they now call "Total income" seems to be very erratic over the period, but for some reason their Net Earnings (PAT) figure seems to always gradually rise. This seems a little odd, but perhaps there is good reason. However what I find somewhat alarming is the negative position of their "Net cash from operations" figure for both 2018 and the recent 2019 ARs. The most recent seems to be pretty hefty - almost twice the magnitude of that year's earnings.
Whilst I appreciate that many here may hold LGEN in a high regard, I think it's reasonable to be wary of these figures and perhaps question why LGENs business can result in steadily increasing net earnings but these recent net CFO shortfalls. Any ideas anybody?
In addition to my concerns above regarding negative Net CFO for the two consecutive years, I'm curious as what exactly LGEN do and how that can create value. All I knew prior to reading AR2019 (which I've not read much of) about LGEN's business was that of Pensions, Insurance and Asset Management. After scanning the first few pages of this report, I came across these five summary business areas on page 16, which I decided to parse and contemplate for a while:
- Institutional retirement
- Individual retirement
Both of the above categories clearly pertain to offer pension fund platforms, exchange pension pots for an annuity and provide pension (and mortgage) advice. Despite hearing that annuity rates are poor (so clearly ppl like LGEN win here) I'm surprised that anything in these areas is particularly lucrative for LGEN. We are now living in times where (apparently) pension fund fees are very low, and hence how much is really left for the providers?
The big area where all the talk is re. Institutional retirement, it seems is something called "Pension Risk Transfer". Apparently this is just fancy jargon for A.N.Other company passing it's defined benefit pension scheme over to a firm like LGEN. I'm struggling to see why this is such a winner for LGEN...but I'm imagine the employee (whose pension is transferred) is the most likely loser, if there is one. I guess for the company, for a one-off known cost, they are rid of an obligation, and for the likes of LGEN - I'm not sure, do they still get any predictable cash flows due to remaining employees (who were on the transferred DB scheme) or must they be content with value of the pot they have just bought i.e. potential profits from any investments therein and residual monies where the holder/spouse die?
- Investment management
From the AR there seems to be a lot of overlap here from investments required to back the DB, DC and PRT pension schemes mentioned above. There also some mention of provision of "regular" investment funds, presumably for retail customers.
All 3 of the above would appear to be areas where LGEN is managing other people's money, so presumably any margin they make must be fee-based, which is increasingly competitive.
I can understand why this business is potentially lucrative nowadays, since by using sophisticated probalistic algorithms LGEN can extract premiums whose total from the entirety of the people being insured, will significantly exceed liabilities. So whilst Black Swan type events (e.g. pandemics!) can potentially upset the rosiness of picture, I imagine that by and large, surplus monies and "float", must give LGEN ample funds to invest and magnify their profits.
- Capital investment
As mentioned above it would appear that LGEN can easily move money around their business, and indeed the fee-based profits and surplus insurance premium can too provide the capital for investing in the markets or in various "projects" such as the urban regeneration, infrastructure, housing, and clean energy to which they refer in their AR.
Furthermore making profitable investment (as we all know) is going to be much harder, and less predictable and require taking on more risk for the foreseeable. From a glance at the table in the post above we can see that in previous years a massive chunk of LGENs cash flows actually derive from dividends. How will this look in their next statement?
Possibly, just a rumour but it appears there is speculation that LGEN are currently sitting on some big losses on the bond markets. I don't how true this is, and whilst it's easy to find many references to this, presumably all the outlets are getting their feed from the same source.
Finally we see like others LGEN taking on more debt now. Is this to be ensure that they can cover the commitment to their promised dividend?
So whilst I am probably not for reducing my LGEN position right now, after taking another look at their business and reading around I don't plan on topping up despite their currently good yield. I may dig around some more, but I'm curious if anyone here either knows more about their business, for example why they account as they do or has more information on their recent ups and downs.