Tip of the week: a solid insurance play

Every week, investment analyst Paul Hill trawls through the press and brokers' reports to find the best share tips around. Here he picks an insurance stock which combines the possibility of a lucrative takeover with strong fundamentals and huge global footprint.

Prudential (PRU), tipped as BUY by Citigroup

The Prudential is the UK's second-largest quoted life insurer (after Aviva). It owns asset manager M&G, with £251bn under management. The firm sells insurance, pensions, fund management and property investments and serves more than 20 million customers worldwide. In the US, it owns Jackson National and it has substantial operations in Asia just last week its Indian interests were valued by HSBC at about £1.5bn.

This geographical diversity is both a boon and a headache for directors. The firm's global footprint gives a healthy balance of mature and fast-growing markets. But vocal shareholders, aware of the rich pickings available from mergers and acquisitions (M&A), are baying for the group to be broken up and sold off. Pension fund giant Hermes wrote to chairman Sir David Clementi earlier this year, asking him to explore ways of dividing Prudential's UK and non-UK assets. Clementi hedged his bets. He said in April that while the current structure gave "material, financial and operational benefits", he would "continue to take account of all alternatives to maximise value for shareholders".

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While a lucrative takeover would be desirable, it is important not to lose sight of inherent value: don't just buy the stock on bid hopes. So what do the finances look like? For 2007, Citigroup expects earnings per share (EPS) on a European Embedded Value basis (EEV) of 71.1p (up from 57.6p last year), rising to 81.7p in 2008. EEV is the main measure of profitability across the industry, as it adjusts operating profits for long-term investment returns.

These estimates are underpinned by a solid set of first-quarter results, which hit the top end of City hopes, and by ongoing cost-cutting measures (offshoring back-office jobs to locations such as India, for instance). At 751p, Prudential's shares trade on an undemanding 2007 EEV p/e ratio of 10.7, falling to 9.3 next year. This is broadly in line with its UK peers, but does not adequately account for its rapidly growing overseas interests. Many analysts put the group's break-up value at around 900p per share. So who would be interested in buying the group? Last year, the board rejected Aviva's "opportunistic" 707p approach, finding it too low. Other possible bidders include France's Axa, Italy's Generali, HSBC, or even private equity.

Fine, but what are the dangers? As with all life insurers, investments are exposed to the stockmarket and regulatory risk. Prudential's overseas activities are also exposed to currency and emerging-market volatility. But with a leading stable of top-notch brands, the stock is a solid long-term holding for more cautious investors.

Recommendation: Long-term BUY at 751p

Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments