How value investors transition to quality investors, the seduction of Jackson Financial $JXN.

Revisiting one of my first wins, is there still gas in the engine?

“I wanna tell her how hot she is but she’ll think I’m being sexist.  She’s so hot, she’s making me sexist.  Bitch.” - Flight of the Conchords

I think Jackson Financial (JXN) is so hot, she’s making me into a quality investor instead of a value degenerate.

In January of 2021, Prudential Financial (PRU) announced their intention to spin off their annuity business as a separate company, JXN.  Annuities were originally within the domain of life insurance companies as fixed annuities came with an estimate of longevity which the life insurance company was well suited to make.  Years of low interest rates and rising stock markets, however, led to the rise of the variable annuity, and with a variable annuity, there is no need to predict the client’s death; the funds can remain indexed to stock market performance no matter how long somebody lives.  However, the necessary derivatives for hedging market and interest rate risk combined with GAAP accounting rules made the variable annuity business undesirable for Prudential.  There was nothing wrong with JXN, it was a fine business, but the GAAP effect of mark to market derivative gains and losses did not align with their vision of stable guidance for the stock market.

JXN was spun off in September of 2021, but not completely, PRU held shares of JXN to sell into the market so that the parent company could monetize some of the spinoff instead of passing the entity entirely to current shareholders.  This selling from PRU weighed on JXN’s share price for the next two years.  During that time, JXN’s business kept improving, paying a dividend and implementing a share buyback program, but the stock price was suppressed by the PRU selling.  

I was, once upon a time, a financial advisor for Merrill Lynch.  I believe in investing only where I am competent, and in the area of investment products, I believe I know enough to take the plunge.  Variable annuities are a very niche investment product, they aren’t right for everybody, but if you have ever seen the outcome of what happens when the financially savvy spouse passes first, leaving the not financially savvy spouse vulnerable to be taken advantage of, often by their own children, you might be a strong advocate of locking that money up in a variable annuity too.  Yes, the commissions are high, and this results in pushy sales tactics for a product that is not suitable for everyone, but they serve an important purpose for people who are so risk averse that they absolutely need guarantees.  

From the point of view of the business, variable annuities are amazing.  The customers are sticky, because surrendering an annuity is very costly.  And regarding the volatility and variable guarantees, if the bean counters are doing their job well, and JXN’s are, then the house always wins.  Another good aspect of JXN is that the business unit is relatively young; PRU was targeting younger clients so JXN’s client base are youthful as far as annuities go, they are not facing an imminent wave of account holders expiring.  JXN’s business model is to not compete on price, but rather compete on quality, and on paying higher commissions than their competitors.  This has given them market leadership in retail variable annuities, usually coming in first or second place in variable annuity sales depending on the year.

Regarding tailwinds, American boomers have about $75 trillion in assets.  For married couples on average the man is 2.5 years older, and dies about 6 years younger than the wife.  This means that the average married woman will be a widow for around ten years.  In a lot of traditional families, the man handles the finances, and the wife is just not that prepared to take on that role at the age of 75 or older.  That family dynamic might not be true for millennials and gen X anymore, but for the septuagenarian cohort, it is still mostly true.  This is an enormous amount of wealth and a gigantic demographic of people that would be appropriate candidates for a variable annuity with JXN’s very popular add-ons of guaranteed income for life, and legacy benefits.

Valuing JXN is tricky, their income statement is constantly whipped around by their hedging strategy.  Normally I would say to beware non GAAP measures in investor presentations, but in this instance, they are essential to understanding operations outside of hedging activities.  Conservatively, if JXN netted 1% in annual fees on their $320 billion of assets under management, the same as a C-share mutual fund, that should result in about $3 billion of net income a year.  If you look at net income since the spinoff, it averages pretty close to my back-of-the-envelope estimate.  Again, the variability in net income is due to GAAP mark to market losses and gains on derivative hedges, which make the business fundamentally stable, but appear unstable on the income statement at first glance.

How much should you pay for a business that will average $3 billion in profits a year, grows as they sell new policies, grows as the assets under management rise with the market, takes very little risk, and engages in share buybacks?  Shares outstanding are already down 23% since the spinoff.  I think JXN is on its way to a Price to Earnings Ratio of 10.  That would imply a market capitalization of around $30 billion, or about a 6x from here over who knows how many years, not including buybacks in the interim.  Yes, there is still gas left in the tank.  It was a better buy when the stock was $35, but it is not anywhere near overpriced.  It might take the market a while to recognize the masked stability, but inclusion into the S&P 600 and the end of PRU selling have already caused a huge improvement to the stock price. 

In 2023, JXN was the second largest variable annuities writer with $12.14 billion in variable annuities written, behind only Equitable Holdings (EQH).  But in total assets under management, JXN still surpasses EQH with $320 billion to $270 billion.  EQH has a market cap of $13 billion to JXN’s $5.5 billion.  Just on that comparison alone, JXN has room to triple from here while it is growing and buying back shares.  And the longer it takes for a multiple rerating, the more effective the buybacks are in the interim.

If I had any sizable assets under management as a portfolio manager, I think JXN would convert me into a quality investor instead of a value investor.  JXN started out as a value stock to me when I found it at $35 a share, and its market cap was half of where it is now, but it has become a quality stock that I wouldn’t mind owning for years, and if management doesn’t make serious mistakes, decades.   Why work hard if you can just buy and hold JXN, keep an eye on the bean counters’ earnings calls, and enjoy amazing returns?  So far I have only found two true quality positions, JXN and the St Joe Company (JOE), but if I had ten or fifteen, and investors who trusted their capital with me, I would switch from being a value degen to being a quality portfolio manager and bring my laptop to the beach for a much less stressful existence.  Expect a writeup on JOE in the near future.