L&G has self-assured look

Be it bid target or bidder, the insurer seems to have covered all the angles as it goes for growth
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It hardly seems to matter into which bit of the life assurance pie the investor sticks his thumb these days: plums seem to come out every time. Scottish Amicable has in effect resigned itself to being taken over, with Abbey National and the Prudential preparing for a fight which neither can afford to lose, for prestige reasons as much as profit.

But the market is convinced that Scottish Amicable is just the appetiser. Other mutuals are ready to be swallowed, and since it is unlikely there will be enough mutuals left to satisfy acquisition hunger in the industry, the chances are that the quoted companies will start to devour each other, and the banking sector will then snap up the best morsels for themselves.

The City seems so convinced that the end result will be larger than the sum of the parts that the shares of the likely bidders are rising, not just those of the potential victims. Compared with the two giants in the quoted sector, the Pru and Aegon, the third largest player - Legal & General - is only half their size, with a market capitalisation of pounds 5bn.

It is big enough to compete with the big boys, and grow and diversify by acquisition as well as organic growth. But it is not too big to escape the attentions of a European insurance giant or one of the clearing banks such as Barclays or NatWest if they decide the time has come to expand again.

Even without a bid premium, Legal & General looks well placed to sustain steady growth for the foreseeable future. The turnover and profitability of the life assurance sector suffered severely from the twin clouds cast by the recession and the effect of the mis-selling of personal pensions on customer confidence. But L&G shares have been consistently strong performers over the past two years and the 2.5-for-one share split last autumn only seemed to prime them for a further surge.

The adverse effects of competition and the slowdown in new business while the financial services industry has been under a cloud have been offset by the effects of rationalisation and cost-cutting, and most recently by a fresh surge in new business.

Competition will certainly remain strong in the sector, but there is little doubt that opportunities are there for the taking. In 1996 L&G reported a 36 per cent rise in new business worldwide, and a 54 per cent gain in new business in the UK. New pensions business grew by 25 per cent, and L&G outgrew rivals like Standard Life and Scottish Equitable. Unlike some of its mutual rivals it also seems to be making gains on its new business, with an estimated 23 per cent embedded profit.

Whatever the outcome of the general election, opportunities in the life, pensions and health insurance business seem certain to multiply. The recovery in the housing market is a good sign for a group which still gets 40 per cent of its individual new business from mortgage-related products. L&G has shown itself dedicated to introducing new products. It is a market leader in producing low-cost PEPs, including tracker funds and the Election PEP currently on sale. It is committed to the expansion of the private health-care market, and it has just re-entered the annuity market. L&G is also known to be planning to enter the banking market in an attempt to hold on to the cash from maturing policies which until now has been syphoned off by banks and building societies.

If anyone can grow market share in an expanding market it will be L&G. Published profits for 1996 may not immediately reflect the positive effects of cost-cutting, innovation and an upturn in new business. After a leap to pounds 271m in 1995, brokers are expecting only modest growth in 1996, although most are anticipating pounds 270m to pounds 300m. Indeed, some are currently revising their forecasts upwards.

On that basis the shares now look relatively expensive at 398.5p, and 26 times forecast earnings per share for the year just ended.

Rating a life assurance company is a notoriously arcane process, however, and relies heavily on the calculation of embedded value of shareholders' funds derived from past profits. But the dividend has grown by an average 14 per cent over the last five years. Brokers at Merrill Lynch steadfastly keep the shares on the accumulate signal, simply because they continue to perform well in what has to be one of the three fastest-growing major market sectors over the next decade.

Legal & General

Share price 398.p

Prospective p/e 25.4*

Gross dividend yield 3.5%

Year to 31 Dec 1993 1994 1995 1996* 1997*

Pre-tax profits (pounds m) 181 169 271 279 311

Earnings p/s (p) 12.2 9.07 15.9 15.7 17.2

Dividend p/s (p) 8.04 8.68 9.76 11.1 12.7

*REFS consensus forecasts