The COVID recession has undoubtedly been painful for many portfolios, with certain sectors being hit harder than others. Clearly, the technology and consumer staples sectors have held up strongly, but financials have been among the hardest-hit sectors.

Every recession is different, and unlike prior recessions, the one that we are in now is not due to structural issues with the economy. The U.S. GDP was on track for another year of growth until COVID hit. While bringing it back to pre-pandemic levels will undoubtedly take time and plenty of effort, I do believe that we will get there in the next year or so. In the meantime, there are still some bargains to be had in the market.

Principal Financial Group (PFG) is one company whose stock price has been hit hard and is yet to recover. While headwinds remain for Principal Financial, I believe the company can pull through fine based on prudent risk management and a strong 10-year track record of growth.

Plus, in today’s low rate environment, I find the 5.2% dividend yield to be attractive. When combined with potential price appreciation from today’s depressed levels, I believe investors will be rewarded for years to come.

Underperformance Spells Opportunity

Principal Financial Group is a diversified financial services company with $631 billion in assets under management (AUM) that provides retirement plans and insurance. It has a leadership position in its areas of expertise, as follows:

(Source: Company website)

Looking at the 6-month performance chart below, shares have underperformed the S&P 500 by a wide 17% margin, and performed more or less in line with the broader financial sector, represented by the Vanguard Financials ETF (VFH). It seems based on the chart below that the market has undeservedly painted financially durable companies such as Principal Financial Group with a broad brush based on perceived risk.

(Source: Yahoo Finance)

Position of Strength

Principal Financial Group entered into the COVID recession from a position of financial strength. As the CEO remarked on the last conference call, the company is in a better position than it was entering the Global Financial Crisis of 2008-09. As seen below, the company has plenty of liquidity to weather the crisis with $3 billion in total available cash and liquid assets, and a low debt to capital ratio of 22%, with no debt maturities until 2022.

Its excess and available capital stood at $1.7 billion. This equates to a 409% Risk Based Capital (RBC) ratio, which, according to the SEC is well above the 200% requirement that most states require.

(Source: Company presentation)

Digging into the financials, the firm’s growth has shown no signs of slowing down, having grown its revenues by 96% over the last 10 years. It grew an impressive 14% YoY in 2019 and 5% so far on a TTM basis.

(Source: Created by author based on company financials)

Even more impressively, Principal Financial grew its operating cash flow by 118% over the last 10 years, with 7% YoY growth in 2019 and 8% growth so far on a TTM basis. This tells me that the company has become more efficient at converting more revenue dollars to the bottom line.

(Source: Created by author)

While AUM took a hit in the latest quarter, the decrease was primarily driven by the point-to-point equity market decline. The firm still saw a net $3 billion in net investment cash inflow despite the pandemic-induced volatility.

In the meantime, the company maintains a conservatively managed investment portfolio comprised primarily of bonds, mortgage-backed securities, and government debt.

(Source: Company presentation)

Principal Financial also maintains solid performance on its funds, with 73% of its funds having a 4 or 5 star rating from Morningstar. It’s also had steady star rating gains on the 3-year bond duration fund category over the past year, and has held steadily high star ratings in the 5-year duration category.

(Source: Company presentation)

Shareholder Returns

Not least of all, capital gains continue to be an integral part of investing in Principal Financial Group with $372 million returned to shareholders in the form of $154 million as dividends, and $218 million in share repurchases. Management has guided for $800 million to $1 billion in shareholder returns in 2020. Applying back-of-the-napkin math, and assuming $900 million in dividends and share repurchases at the midpoint of guidance, this alone could result in a 7.8% total shareholder return based on today’s market capitalization.

As seen below, the company has been aggressive in share repurchases over the past 2 years, having bought back 5% of its float since 2018.

(Source: Macrotrends)

Management also has a strong track record of increasing dividends, as evidenced by the 4% increase this year. With the Fed having reduced interest rates to zero, I find the current 5.2% yield to be especially attractive. The payout ratio currently sits at a safe 46%, giving plenty of headroom for future raises.

As seen below, the dividend per share has grown an impressive 49% since 2015 from $1.5 per share to the current forward rate of $2.24 per share.

(Source: Created by author)

Key Risks

As with any financial services provider, management reputation is extremely important, as perceived transgressions can lead to an exodus of capital and materially reduce assets under management, thereby reducing the fee revenues they receive. This is something worth monitoring.

In addition, low interest rates lead to yield compression, which can hurt earnings from fixed-income investments. I believe this is mitigated somewhat by the record $2 trillion stimulus that the government recently passed, with potentially more to come. As the “new” money flows through the economy, I would expect for it to eventually make its way to funds managed by financial services providers like Principal Financial Group, thereby increasing AUM and fee revenue for the company.

Investor Takeaway

Principal Financial Group operates from a leadership position in its key areas and has a strong 10-year track record of growth. Management continues to apply prudent risk management, as evidenced by its conservative investment portfolio, strong A-rated balance sheet and liquidity. Having taken lessons from the Great Financial Crisis, the company is in a position to weather this crisis while continuing to return value to shareholders.

I view shares as presently undervalued at the current price of $43.01 as of writing and a P/E of 8.2. I have a Buy rating and a one-year price target of $52.50 at what I believe to be a reasonable P/E of 10. This equates to a potential 27% one-year return based on share price appreciation and dividends combined.

(Source: F.A.S.T. Graphs)

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


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