How Jackson Financial Triumphs Amidst Market Volatility

Investment Thesis

Jackson Financial (NYSE:JXN) has had an unsteady ride in the last two years, with shares zigzagging between $25 and $50 per share, mirroring two opposing market forces. On the one hand, at a PE ratio of 2x-3x, the ticker has found support due to undervaluation. On the other hand, the ticker is facing resistance as JXN experiences a loss in market share as management continues its efforts to improve the annuity underwriting mix away from capital-intensive Variable Annuity products.

Annuities are financial securities that guarantee a steady income after retirement. Banks, insurance companies, and other financial institutions sell them.

Despite these challenges, JXN remains a big name in the annuity business. They're not #1 anymore but still in the league, standing at #5 in terms of annuities sold last year. It is a robust business with deep industry ties, marketing operations, and a customer base. What's catching is its current price, selling for a fraction of its Net Asset Value 'NAV' (what the company would be worth if sold today).

In our May article, 'Unmasking Stability Amid Turmoil,' we examined the market's response to JXN's earnings announcement, during which substantial GAAP losses were reported. This shook investors' confidence, triggering a decline in the stock price. Our bullish thesis at the time was based on the temporary nature of these issues, tied to non-cash write-offs of derivatives it uses for hedging future obligations to its customers. Since then, JXN shares surged 33%, vastly outperforming the S&P 500's (SP500) mere 1.6% increase.

Despite JXN's notable share performance, I believe there is more upward momentum to be seen, given that the stock remains undervalued. I see management's ongoing value-creation initiatives as a catalyst for the bullish thesis. JXN plans to give back $500 million to shareholders in dividends and share buybacks. This might not sound much, but it is an impressive figure for what investors are paying. To give you a picture, this $500 million is 17% of the current market cap.

Valuation

Lately, people don't seem particularly optimistic about the economy. Prices for everyday things like gas, food, and rent are high. Investors are worried about the Fed's next move. If you're not feeling the heat, the Conference Board Consumer Confidence Survey makes it official, with the index down for the second consecutive month in September.

As a barometer for the economy's health, valuations in the finance sector mirror these challenges. These days, an 8x PE ratio for a finance company is considered fair, much lower than the broader market's 24x.

JXN's $3 billion market value falls short of its real worth, but it is admittedly within the finance sector's range. In fact, some of its peers trade at a comparable valuation, as shown in the table below:

It doesn't matter that JXN is trading at a comparable valuation to some of its peers. The entire Life Insurance and Annuity market is undervalued, limiting the usefulness of comparative valuation. Market valuations are not always efficient. Look at recent M&A in the sector, and you'll see that the real smart money is willing to pay much more for these assets in the annuities and life insurance market. Earlier this month, Prosperity Group announced an agreement to buy National Western (NWLI) for $500 per share, 87% above market value at the time of the deal. The deal price is still below NWLI's NAV of $626 per share, but it is much better than what the market was valuing NWLI.

Brookfield (BAM) bought American Equity (AEL) for $55 in July 2023, 42% above what AEL was selling at the market. In this particular case, the acquirer was willing to pay AEL above its NAV per share price of $32 per share, further proving our point.

Jackson is trading at 41% NAV. This is an attractive value, no matter what the market is saying, and who knows? As one of the two pure annuity companies (the other is F&G), JXN might soon be an acquisition target.

As of June 2023, JXN's $327 billion balance sheet assets consisted mostly of customer investment accounts, countered by a comparable balance of liabilities for future annuity payment obligations. This structure, which is typical for an insurance company's balance sheet, ensures that a significant portion of market risk is passed to the customer. Risk for JXN's propriety accounts is hedged through a robust investment strategy resting on investment-grade debt instruments.

Bears will argue that JXN's product mix remains a concern. Since our latest article, Moody's downgraded JXN's Financial Strength rating from A2 to A3. While this remains an investment grade, it mirrors the stakes of management's initiatives to diversify its product mix from capital-intensive Variable Annuity business.

The market reaction to Moody's downgrade was subdued. While not ideal, this rating downgrade is counterbalanced by an undervalued, investment-grade balance sheet with statutory capital well above regulatory requirements.

How I Might Be Wrong

Analyzing insurance companies is a bit tricky. GAAP earnings are connected to the whims of capital markets, adding a layer of unpredictability that blurs the analytical lens. Adding to the complexity is underwriting risks. As outsiders, we don't have access to Jackson's contracts, and issues are only known after it's too late. Thus, when it comes to the insurance sector, reputation is key.

JXN, despite its relatively new presence on the stock market, carries a legacy stretching back to the 1960s. Until recently, it was a subsidiary of the globally renowned Prudential plc (PUK), a prestigious insurance company headquartered in the UK. Tight regulations are also a safety layer.

Wall Street is casting a less favorable outlook on JXN than I am, with all four analysts covering the ticker landing on a 'Hold' rating. A deep dive into the balance sheet shows a solid financial position, with nearly all assets invested in investment-grade bonds. Wall Street's skepticism likely stems from the JXN's market share erosion for the past 18 months. In the eyes of a growth-hungry Wall Street, this is a glaring red line. But in all seriousness, the situation could be better. The market is expanding as customers seek more safety in annuity assets, but JXN is selling less than it did in prior years. Still, the bullish thesis on JXN rests on a firm foundation: a strong balance sheet, undervaluation, safe dividends, and a shareholder-friendly buyback program. These pillars present a counter-argument to Wall Street's 'Hold' rating.

Summary

Despite tumultuous market conditions and a recent decline in market share, I believe that JXN is poised for a rebound. The present valuation of JXN, trading at a significant discount to NAV, is an opportunity. The recent acquisition deals in the sector highlight buried value, with M&A deals being signed on prices much higher than the market's

While you wait for a clear catalyst that would reprice JXN up, investors are expected to collect a 6.5% yield, plus an approximately $250 million share buyback program, which brings the total return to 16%.