Jackson Financial: A Puff From The Annuity Cigar Butt

seekingalpha06-06

Jackson Financial has produced attractive returns for investors, with total returns almost tripling in less than three years.The company's financial history shows revenue and earnings volatility due ...

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JXN Total Returns Full History (Seeking Alpha)With less than three years as a separate, public company, the total returns of the stock are almost 3x, and much of that has occurred recently. It's worth reviewing what's going on here and if there's room for more return. I believe there is more room, not quite as much as before. While it is a Buy, investors should know that there doesn't seem to be a growth story beyond management's wishful thinking. JXN is merely a cigar butt. Brief Financial History Jackson is the product of a spinoff from London-based Prudential plc (PUK) in 2021. While they have disclosed their financial history for their time as a subsidiary going back a few years, it's a limited span of data.   Author's display of 10K dataRevenue movement has been all over the place, much higher in 2018 and seeing a spike in 2022 as well.   Income Statement (2023 Form 10K)A look at the income statement shows that, while the numbers for fee-based income and net investment income are more stable, the revenue volatility is a consequence of losses on their derivatives and reinsurance treaties. In general, I get leery about companies that rely on hedges as a key portion of earnings.   Author's display of 10K dataSimilarly, GAAP earnings have been volatile and not consistently positive.   Seeking AlphaI think another thing to consider, though, is that operating cash flows are consistently positive, derivative concerns aside.   Seeking AlphaCuriously, JXN has traded at huge discounts to tangible book value and even earnings per share.   Capital Returned to Shareholders (Seeking Alpha)Management has been keen to seize on this through buybacks since the beginning, with increasing dividend payments, both of which are significantly less than even a weak year's earnings. Overall, it's not disastrous financials but not impressive either. Business Model This apparent mismatch between EPS, TBV, and share price is perplexing. I think this is due to the relative youth of the separate company, as well as the fact that it's in an area of business that may not be as straightforward to many investors: annuities. Jackson primarily earns fees from their annuity products that are sold to investors.   Annuity Sales Breakdown (2023 Form 10K)Most of their sales and accounts are in variable annuities, with RILAs being a fast-growing part of the business. In an effort to help investors focus on their core operations, they provide Adjusted Operating Earnings.   Adjusted Operating Earnings (2023 Form 10K)Stripping away impacts from their hedges and changes in the value of their portfolio, AOE gets us a stabler figure, but this also shows a trend of decline, just over $2 billion in 2021 and only about $1 billion for 2023.   Annuity Segment Income (2023 Form 10K)The decline in the income from their annuity segment explains nearly all of this difference.   Net Flows (2023 Form 10K)Crucially, Net Flows (change in customer account values unrelated to performance) is consistently negative. Their annuity business is bleeding, and this picked up in 2023.   Q1 2024 Net Flows (Q1 2024 Form 10Q)This is a trend that has continued into Q1 of this year. This is odd, considering this remark in their 2023 Form 10K (pg. 8): According to LIMRA LOMA U.S. Individual Annuity Sales Industry report, for the nine months ended September 30, 2023, we accounted for 12.1% of all sales in the U.S. variable annuity market and ranked #2 in variable annuity sales. One might think such an industry leader wouldn't experience this. In spite of it, they discuss their strategy going forward: We are increasingly focused on growing sales through our Independent RIAs, Platforms & Agents (\"IPA\") channel. We facilitate the sale of annuities by RIAs by offering them use of an insurance support desk that satisfies insurance- related licensing and regulatory requirements. So it's a business of selling these (mostly variable) annuity products and depending on third-party players to help make that sale for them. Balance Sheet   Balance Sheet (Q1 2024 Form 10Q)Removing the special account items for their annuities, Jackson has $109.5 billion in assets, on top of $99.2B in liabilities. While it's not the worst balance sheet, their $60B investment portfolio is valued less than their $66B insurance liabilities. This creates potential for a squeeze in an especially bad year. Future Outlook I think a bet on Jackson is a bet on variable annuities and (increasingly over time) RILAs. Let's break down, though. Cycles LIMRA reported that total annuity sales peaked in 2023 but that this was largely seen in fixed annuities. Investors who care about annuities wanted to lock in those guaranteed higher rates. Thus, it's reasonable to assume that Jackson's business will be exposed to cyclicality between fluctuating demand for variable and fixed annuities. We might question if variable annuities will have a lot of staying power across cycles, though. Scraps and Leftovers Having worked previously on 401Ks at Fidelity and just seeing the general attitude on annuities, I don't think it's going to be booming. Annuities were generally treated as a retirement benefit of last resort, used after maximizing 401Ks and IRAs and needing some other conduit of tax-deferral for whatever was left. This implies they are high net-worth clients, but it also means the annuity is getting their scraps, while the lower earners appear to have been taken over by 401Ks-driven advice and will almost never be guided to an annuity outright. For anyone that was earning more than their 401K or IRAs would allow, I generally got the impression that they knew how to invest and therefore didn't need a more complex product like an annuity. They would just put their extra savings into a personal business, buy some real estate, or even use a normal brokerage account to buy blue chips/ETFs. ETF Country On that note, the rise of ETFs over the last decade has already started the death clock for mutual funds. ETFs, meanwhile, experienced a CAGR in AUM of 15% from 2010 to 2022. We would do well to ask ourselves how annuities fare in this change world of investing. I think the reason mutual funds have suffered isn't surprising. They are functionally the same as open-end funds, except MFs are harder to buy and sell and with more costs built into the transactions as well. This is something annuities have in common with MFs, compared to the simplicity and liquidity of ETFs. Moreover, Jackson said they need independent RIAs to sell their annuities for them. I ask myself: How much are the big players, like Fidelity, Vanguard, and Schwab going to recommend Jackson's annuity product? No, I think more and more long-term savings are going into ETFs run by popular players. Valuation This is one of the trickier valuations I've had to do because I don't have the long-term confidence to do a growth-focused calculation. The only thing that really makes sense at this point is treating it as a potential liquidation play. As of Q1, tangible book value is about $10B, against a market cap of about $5.56 billion. This means the current TBV per share is about $125.   Q1 2024 Form 10QMoreover, we know the company is actively buying back its shares, and as long as they continue to report earnings in excess of buybacks and dividends, TBV per share should continue to increase at these prices. Conclusion My overall take on Jackson has been one of skepticism and caution, given mediocre financial results based on what I think is, frankly, a mediocre investment product: the annuity. This likely also explains its historically low P/E and P/Book ratios and the market's own pessimism.  Having said that, I think Jackson represents an example of a cigar butt, a Ben Graham stock. While share prices have leaped from the $20s to the $70s, it's still at a 45% discount to TBV, and continued buybacks can pull that up some more. For such a stock, a substantial margin of safety is in order, and JXN currently gives one, but it was clearly better a year ago. The mathematics for the current price make it an acceptable Buy, but anyone who moves forward should probably have an exit plan. 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