Prudential Financial Stock: Buy This 5.5%-Yielding Blue-Chip Bargain (NYSE:PRU)

The October data from the Senior Loan Officer Opinion Survey on Bank Lending Practices or SLOOS showed an elevated risk of a recession in the U.S. economy. The most recent data implies that if the U.S. economy isn’t already in a recession, it has a nearly 90% probability of entering into one in the next 12 months.

Since a recession is almost a near-certainty between now and 2024, investors need to position their portfolios accordingly. My strategy is to focus on owning businesses that have been in these situations and have come out stronger time and time again.

As I noted in my previous article on Prudential Financial (NYSE:PRU) in September, the company has been in business for nearly a century and a half. This period included challenging times such as the Great Influenza epidemic of 1918-1920, the COVID-19 pandemic, the Great Depression, the Great Recession, and so much more. After all of these difficult events, Prudential has proven that it has what it takes to stand the test of time.

Let’s revisit Prudential to understand why I am reiterating my buy rating.

In this environment of high rates, the risk-free 10-year U.S. treasury rate is 4.5%. Prudential sports a dividend yield of 5.5%, which is a full 100 basis points greater than the risk-free rate. The company’s 41% EPS payout ratio is also meaningfully lower than the 50% EPS payout ratio that rating agencies view as safe for its industry.

As I’ll discuss further as the article progresses, Prudential also stands on a solid foundation financially. The company’s debt-to-capital ratio of 0.35 is elevated relative to the 0.2 ratio that rating agencies prefer to see. Yet, S&P assigns an A credit rating to Prudential on a stable outlook. This implies that the chance of the company closing its doors between now and 2053 is just 0.66%. Simply put, Prudential has been around longer than any of us have been alive and it will likely be here long after we’re all gone.

If that wasn’t enough, the financial giant is also priced like a business that’s on sale. Averaging out historical fair value metrics like dividend yield and P/E ratio, Dividend Kings’ fair value is $111 a share for Prudential. This is pretty close to my fair value of $100 a share, which I arrive at through the following inputs into the dividend discount model: A $5 annualized dividend per share, a 10% annual total return, and a 5% annual dividend growth rate.

Averaging out Dividend Kings’ fair value estimate and mine, Prudential is trading at a 14% discount to fair value against its current $91 share price (as of November 8, 2023). Assuming the company grows as anticipated and reverts to fair value, here is what total returns could look like for the next 10 years:

• 5.5% yield + 3.2% FactSet Research annual earnings growth consensus + a 1.5% annual valuation multiple boost = 10.2% annual total return potential or a 164% cumulative total return versus the 10% annual total return potential of the S&P 500 (SP500) or a 160% cumulative total return

A Robust Showing In The Third Quarter

Prudential turned out another respectable quarter for its shareholders. The company’s after-tax adjusted operating income per share surged 45.1% higher year-over-year to $3.44 during the third quarter.

Strength in the company’s U.S. Businesses and International Businesses segments offset a slight decline in the Prudential Global Investment Management or PGIM segment in the third quarter.

In the U.S. Businesses segment, higher investment spreads from elevated interest rates and lower expenses were only partially offset by lower fee income for the third quarter. That is how the segment’s adjusted operating income soared 76.9% over the year-ago period to $1.088 billion during the quarter.

In the International Businesses segment, the story was much the same. More favorable investment spreads propelled adjusted operating income 8.4% higher year-over-year to $811 million in the third quarter.

Lower co-investment income and higher expenses in the PGIM segment pushed adjusted operating income 3.7% lower over the year-ago period to $211 million.

Shareholders also received a bigger slice of the pie of Prudential’s higher overall profits. This is because the company’s share repurchases lowered the diluted share count by 2.5%.

As the U.S. grows older and richer, the need for Prudential’s products and services should continue to rise. This is why FactSet Research thinks the company’s earnings will grow by 3.2% annually over the long term.

Turning to the balance sheet, Prudential is as prepared as ever for a financial downturn. That’s because the company had $4.3 billion in liquid assets as of September 30, 2023. For context, that’s within its targeted range of between $3 billion and $5 billion. This gives Prudential the resources needed to service its debt, as well as to withstand a temporary economic slide.

Decent Dividend Growth Lies Ahead

Prudential’s quarterly dividend per share has grown by 38.9% over the last five years to the current rate of $1.25. This equates to a 6.8% compound annual growth rate.

While this level of growth can’t persist, I do believe mid- single-digit annual dividend growth can keep up moving forward. This is because aside from its low-40% earnings payout ratio, Prudential has covered its dividend several times over with free cash flow so far this year.

The company has generated $5.4 billion in free cash flow through the first nine months of 2023. Against the $1.4 billion in dividends paid during that time, this works out to a 25.7% payout ratio (sourced from page 10 of 210 of Prudential 10-Q filing).

Risks To Consider

Prudential is an above-average quality business, but it still has risks that shareholders must be able to tolerate.

As I highlighted in my previous article, risks of a recession/underwhelming financial market performance and higher-than-expected insurance claims remain for the company.

Another risk to Prudential is that it is highly dependent on the trust of its brand to sell its products and services to customers. If an event were to undermine the trust people have in the company, its fundamentals could suffer.

Finally, Prudential has a great deal of sensitive information that cyber thieves find attractive. If the company can’t stay one step ahead of cyber breaches, it could fall victim to such a major incident. That could lead to significant legal liabilities and damage its reputation.

Summary: Get Paid Well For The Chance To Crush The Market In the Next Two Years

Prudential’s blended P/E ratio is currently less than 8, which is well below its historical P/E ratio of 10.6. This is despite fundamentals that are arguably intact, which is why the stock could offer huge returns through the end of 2025.

If Prudential returns to its normal P/E ratio, investors could be set up for 30%+ annual total returns in the next two years. Looking out over a 10-year horizon, the company could slightly outperform the S&P 500. That’s why I believe Prudential is still a buy for income investors who also want value.