Initiating Coverage with a Hold Rating

16 October 2018Insurance / LifePrincipalRatingHoldValuation & RisksFinancialInsurance / LifePrice at 15 Oct 2018 (USD)54.58Price target61.0052-week range71.76 - 57.09Initiation of CoverageNorth AmericaUnited StatesCompanyPrincipalReutersBloombergExchangeTickerPFG.NPFG USNYSPFGDate16 October 2018Deutsche BankResearchInitiating Coverage with a Hold RatingSell-Off in PFG shares may prove persistentYear-to-date, shares of Principal Financial Group have fallen 20%, including 9%over the past five trading days. Historically, such a sell-off had resulted in arelatively discounted valuation such that it presaged a rally in the stock soonto follow. However, the sell-off in PFG shares echoes, not only a sell-off amonglife insurance peers broadly, but also a radical downward re-valuation of assetmanager stocks. As investors fear 1) the potential for peaking industry AUMand 2) the long-term expectation of fee contraction among asset managers, weexpect Principal's investment management-heavy business orientation will keepits valuation tied to asset managers, with lower sensitivity to interest rates vs.life insurance peers. The life insurance and asset management peers may beundervalued, but Principal does not appear particularly undervalued relative towhere those peers trade. Limited upside informs our Hold recommendation.EPS growth held in check by industry dynamicsIn years past, Principal's heavier weighting toward asset management businessespositioned it as a preferred name among the large-cap life insurance peersbecause of its lower capital intensivity and reduced market sensitivity comparedwith some peers. However, industry dynamics have shifted such that competitionin Principal's capital light lines of business tether margin expansion and earningsgrowth. Currently, annualized EPS growth at Principal on consensus numbersruns to the lower end of the range (5-6%) compared with peers, and our forecastis modestly below the Street.International growth presents optionality, but that opportunity is deep in thefutureThe company's $311B in AUM (as of 2Q18) in the emerging International markets(half represented by China with beachheads well-established in Brazil and Chilealong with startup businesses in a handful of other emerging economies) runs atmaterially higher margins than the mature market businesses in the U.S. Fundflows are positive and could accelerate if the company is able to convert any ofits start up initiatives (UAE, India, Singapore, Hong Kong, etc.) into a viable long-term platform. However, we don't believe investors will see this convert into betterEPS growth for the foreseeable future.Initiating with target price of $61; risksOur price target is based on equal weighted approach of (1) a forward operatingrisk-adjusted return-to-P/B (ex. AOCI) regression and (2) a relative forecast price-to-operating earnings multiple. We give the P/E valuation a greater weighting inJoshua ShankerResearch Analyst+1-212-250-7127Sam Desai, CFAResearch Associate+1-212-250-9761Grace CarterResearch Associate+1-212-250-2628Phil StefanoResearch Analyst+1-212-250-5778Price/price relativePrincipalS&P 500 INDEX (Rebased)201520162017255075Performance (%)1m3m12mAbsolute2.612.619.1S&P 500 INDEX4.37.018.3Source: Deutsche BankStock & option liquidity dataMarket Cap (USDm)15,609.9Shares outstanding (m)286.0Free float (%)100Volume (15 Oct 2018)925,809Option volume (und. shrs., 1M avg.)35,332Source: Deutsche BankDeutsche Bank Securities Inc.Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should beaware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should considerthis report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONSARE LOCATED IN APPENDIX 1. MCI (P) 091/04/2018.Distributed on: 16/10/2018 20:06:08 GMT7T2se3r0Ot6kwoPaProvided for the exclusive use of Research Research at Provisional Access on 2018-10-17T01:28+00:00. DO NOT REDISTRIBUTE 16 October 2018Insurance / LifePrincipalPFG's case compared to the life insurance group because of its fee orientation,which means that it takes less balance sheet risk than most life insurers. Shouldmarket conditions stabilize or improve enough for the company to translate AUMgrowth into margin expansion, the company will likely beat our estimates. Giventhe sizable goodwill on the company's balance sheet, book value is at risk ofimpairment if these assets cannot be converted into a long-term healthy earningsstream. The company's performance is strongly tied to its credit ratings, whichinform capital deployment and balance sheet flexibility.Forecasts and ratiosYear End Dec 312017A2018E2019E1Q EPS1.271.40A1.422Q EPS1.311.35A1.513Q EPS1.281.701.554Q EPS1.191.401.53FY EPS (USD)5.055.856.00OLD FY EPS (USD)–––% Change–––P/E (x)12.79.39.1DPS (USD)1.872.102.28Dividend yield (%)2.93.84.2Source: Deutsche Bank