Don’t be distracted by M&G’s dividend

That’s one inference from the subject of many articles that perform well on our website. A lot of Investors’ Chronicle readers, it would appear, quite like fat dividend cheques. And as the only FTSE 100 constituent with both a double-digit trailing and forward dividend yield, the financial services group is a favourite of those who invest for income, and the optionality that regular distributions provide.

If recently installed chief executive Andrea Rossi keeps the interim payout at 6.2p per share (or better still, matches the consensus market expectations of 6.4p), that will instil confidence in a repeat of 2022’s full-year dividend of 13.4p. The City, forecasting 13.7p, is optimistic.

To some, however, a 10 per cent yield is a scant reason for confidence. For lots of firms, executives and investors, the transfer of so much capital from business to shareholder each year is either evidence of a lack of investment options or simply unsustainable from a cash flow perspective.

Yet if the persistent fear is that M&G’s dividend train is about to hit the buffers, then the company has repeatedly defied expectations since its spin-off from Prudential (PRU) in October 2019. Since that demerger, and the 3.85p-a-share special dividend that accompanied it, M&G has paid out 71.9p in distributions, or a third of its initial 220p market value, in under four years. The company also found room to repurchase £500mn-worth of shares in 2022.

With the shares now changing hands at 191p, M&G has posted a 25.5 per cent total return since listing, or a 19.5 per cent return if you simply let the cash build up in your investment account. The FTSE All-Share, whose fall during the first months of 2020 was far less dramatic than M&G’s, has returned 15.1 per cent over the same four-year period.

To date, operational performance has been decent. Despite being hit by negative market movements in 2022, the group met its target to generate £2.2bn in total capital in its first full three years of listing. The first three months of 2023, by contrast, saw stable asset flows to its wealth, client and asset management arms, while its Solvency II coverage ratio – a measure of insurer capital safety – edged up to 200 per cent, double the regulatory requirement and ahead of a 160 to 190 per cent target.

What, then, is the catch? In short, the key bear argument remains the epithet that analysts at Exane BNP Paribas assigned at IPO: “A fixed-income-focused asset manager with a run-off insurance business.” Though M&G’s focus on bonds has shielded it from some of the asset management sector’s sharpest pain, an important source of revenues from defined-benefit pension schemes is shrinking. Cost-cutting, designed to staunch the bleeding, isn’t a long-term strategy.

However, four years on and with interest rates 4.5 percentage points higher, the outlook for the insurance business is better. Rossi has also pitched the asset management division as a potential international force and wants the wealth arm – spearheaded by the PruFund range – to expand. By 2025, the ambition is for wealth and asset management to make up more than half of earnings, from around two-fifths currently. Assuming the Heritage run-off business maintains its distributions, that implies combined profit growth of at least a third.  

Analysts at RBC reckon this means the group will continue to meet its target for capital generation, pay its market-leading dividend, and free up capital by offloading risk to reinsurers.

The bigger problem is that the ultimate drivers of the things that matter most to investors – profit margins, product demand and balance sheet strength – are either opaque or dictated by macroeconomic forces beyond M&G’s control. While this is a charge one could lay in front of much of the financial services industry, it feels particularly pronounced in hyper-competitive markets where growth has been targeted, but not yet delivered.

Ultimately, even a high-yield play needs a growth story. When they turn to M&G’s interims next week, signs of this are what prospective income investors should look for first.