Prudential (LSE: PRU) (NYSE: PUK.US) impressed markets with a 17% increase in operating profits in 2013, backed up with a 15% increase in the firm’s full-year dividend, which rose to 33.6p, giving a yield of 2.4%.
Prudential’s Asian and US growth stories appear to be intact, but even the most bullish investor should probably take note that the firm’s shares currently trade on 26 times reported earnings, and have risen by 575% over the last five years.
Spectacular growth stories such as Prudential’s usually come to a halt at some point — sometimes quite painfully. I’ve been taking a closer look at some of Prudential’s key financial ratios to see if I can spot any red flags.
1. Operating profit/interest
What we’re looking for here is a ratio of at least 1.5, to show that Prudential’s operating earnings cover its interest payments with room to spare:
Operating profit / Operational finance costs
£2,954m / £305m = 9.7 times cover
Prudential’s operating profits cover its interest payments (those related to its business, not investments) by almost ten times, so there’s very little risk that debt servicing costs will threaten dividend payments.
2. Debt/equity ratio & cash generation
Commonly referred to as gearing, this is simply the ratio of debt to shareholder equity, or book value (total assets – total liabilities).
Prudential’s 2013 accounts show that its net corporate debt is just £898m, giving net gearing of just 9.3%, which is very low risk indeed.
I don’t see any realistic likelihood that Prudential’s corporate debt could interfere with its dividend, especially as the firm generated surplus cash of £2,462m in 2013, covering its combined interest and dividend payments by 2.3 times.
3. IGD capital surplus
The Insurance Groups Directive (IGD) capital surplus sounds a bit of a mouthful but is actually a very simple — and important — figure.
Insurance firms have to hold a certain amount of surplus capital to ensure they can cope with unexpected events and financial problems. Prudential’s requirement is around £1.8bn, but the group says that it currently has an estimated capital surplus of £5.1bn, covering its requirements 2.8 times.
This is very comfortable — in comparison, RSA Insurance Group only has coverage of 1.8 times, and Aviva has 1.7 times coverage.
Is Prudential still a buy?
In my view, Prudential shareholders who are sitting on big profits can sleep easy and enjoy the firm’s rising dividend. Although a share price correction is possible, Prudential’s underlying finances look very safe indeed, and I don’t see any risk of an RSA-style meltdown.