Principal Financial Group, Inc. (PFG) Earnings Call Transcript & Summary

Good morning, and welcome to the Principal Financial Group 2021 Outlook Conference Call. [Operator Instructions] I would now like to turn the conference call over to John Egan, Vice President of Investor Relations.

Thank you, and good morning. Welcome to Principal Financial Group's 2021 Outlook Call. Materials related to today's call are available at principal.com/investor. Following a reading of the safe harbor provision, CEO Dan Houston and CFO Deanna Strable will deliver some prepared remarks. Then we will open up the call for questions. Others available for the Q&A session include Renee Schaaf, Retirement Income Solutions; Pat Halter, Principal Global Investors; and Amy Friedrich, U.S. Insurance Solutions. Some of the comments made during this conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. The company does not revise or update them to reflect new information, subsequent events or changes in strategy. Risks and uncertainties that could cause actual results to differ materially from those expressed or implied are discussed in the company's most recent annual report on Form 10-K filed by the company with the U.S. Securities and Exchange Commission. Additionally, some of the comments made during this conference call may refer to non-GAAP measures. Definitions are available in our 2021 Outlook Call slide presentation on our website. Dan?

Thanks, John, and thank you to everyone joining the call. 2020 presented many challenges that Principal met head on. We are agile, innovative and quick to adapt and evolve how we serve our customers. We provided the solutions and the support they needed to better manage through the pandemic. We closed the year with record total company assets under management of over $800 billion, providing a strong base from which our fee businesses can grow in 2021. We continue to take a balanced and disciplined approach to capital deployment. After pausing share repurchases in early 2020 due to COVID and the resulting macro uncertainty, we resumed buybacks in the fourth quarter. In 2021, we're targeting $1.4 billion to $1.8 billion of external capital deployment, including $600 million to $800 million of share repurchases. Principal remains laser-focused on helping more people and businesses on the path to financial security. As a top 3 retirement provider in the U.S., the second largest pension provider in Latin America and a top 40 global asset manager, we leverage our insights and global perspective for the benefit of all of our customers. Our industry leadership reflects broad expertise in managing assets, developing retirement income solutions, creating best-in-class employee benefit programs and helping business owners and individuals manage risk. We expect 2021 will present both challenges and opportunities as COVID continues to disrupt the global macroeconomic environment. However, we continue to see strength and growth among our customers, both here in the U.S. and abroad. On recent calls, we've talked about the resiliency of our small and medium-sized business customers. In our Retirement and Group Benefits businesses, our SMB block continues to perform well with stronger reoccurring deposits, in-group growth and persistency than our total block. We continue to make good progress on the integration of the Institutional Retirement and Trust business. We spent the last 18 months investing in infrastructure and building new capabilities to ensure a seamless transition as well as an enhanced experience for all of our retirement customers. Revenue expense synergies will begin to emerge in the second half of 2021 with an even larger impact in 2022 and beyond. The revenue synergies, including rollovers and proprietary asset capture, will benefit many of our U.S. businesses. With our retirement expertise and global footprint, we continue to partner with governments around the world to promote sustainable long-term savings policies and desired outcomes for their citizens. One example is in Mexico, where Congress passed a groundbreaking pension reform late last year that will more than double retirement savings from 2023 to 2030, with employers notably shouldering much of the new contribution stream. While this will provide a more adequate and sustainable retirement system and lead to future growth for Principal International, the retirement industry will experience further fee compression beginning in 2021. This is reflected in our 2021 guidance. The opportunities that exist for Principal in 2021 and beyond are substantial. And we're extremely well positioned to capitalize on them. We'll continue to adapt as customer needs and preferences evolve with a goal of delivering above-market growth and superior long-term value for our shareholders. Deanna?

Thanks, Dan, and thanks for joining our call today. This morning, I'll discuss our 2021 guidance and our capital deployment plans for 2021. Slide 4 provides our 2021 guidance ranges, anticipated significant variances and our underlying assumptions based on macroeconomics as of the end of 2020. These ranges and assumptions imply an 18% to 20% increase in full year 2021 total company non-GAAP operating earnings per diluted share compared to full year 2020 on a reported basis or 8% to 10%, excluding significant variances in both periods. If we were to update for macroeconomic impacts through late February, we'd expect slightly higher growth. We continue to manage growth and expenses with revenues and expect approximately $100 million of the $250 million of expense savings realized in 2020 to carry over into 2021 with benefits across all of our businesses. Variable investment income is expected to be in line with our long-term run rate in 2021, which can be volatile quarter-to-quarter. As a reminder, the first quarter is typically our lowest quarter for earnings due to seasonality of dental and vision claims and specialty benefits as well as deferred compensation and elevated payroll taxes in PGI. Our 2021 guidance ranges exclude estimated impacts from COVID-related mortality and morbidity. Our outlook assumes 300,000 U.S. COVID-related deaths in 2021, heavily weighted to the first quarter. Based on our sensitivity that is unchanged, this equates to approximately a negative $40 million pretax and $30 million after-tax impact to total company non-GAAP operating earnings. This includes estimated pretax impacts of a negative $40 million in Specialty Benefits, a negative $30 million in Individual Life, partially offset by a $30 million benefit in RIS-Spread. We expect reported pretax margins in RIS-Spread, Specialty Benefits and Individual Life to be impacted by about 1% to 2% from COVID-related mortality and morbidity in 2021. We'll continue to quantify COVID impacts as significant variances on our earnings calls as they occur in 2021. The IRT integration will be completed by late summer. We expect approximately $55 million to $65 million of integration costs in 2021, primarily due to onetime severance-related costs as well as investments in a new trust and custody platform that will drive long-term revenue growth across the enterprise. The integration costs are excluded from the margin guidance for RIS-Fee as they are onetime in nature and, we'll identify the cost as significant variances as they occur throughout the year. The remainder of the IRT business will transition to Principal in 2021 and benefits will begin to emerge in the second half of the year. We expect RIS-Fee's margin to increase throughout the year, starting at the low end of the guidance range, ending at the high end, and building from there as expense synergies increase toward an ultimate run rate of $90 million. RIS-Fee's net revenue growth of 3% to 7% is elevated from the equity market tailwinds in the second half of 2020 and is expected to normalize in 2022. In PGI, we expect strong revenue growth of 9% to 13% and margins of 37% to 40% in 2021 fueled by the equity market tailwinds, a rebound in transaction and borrower fees and performance fees as well as continued expense management. Looking ahead to 2022, we expect to maintain PGI's margin in the 37% to 40% range, but revenue growth is expected to normalize to 4% to 8%. We expect revenue growth to rebound in Principal International in 2021 to 8% to 12% with a 30% to 34% margin. The fundamentals remain strong and macro conditions have improved in recent months, including the impact from foreign currency. In Specialty Benefits, we expect premium and fee growth of 3% to 7% in 2021, slightly pressured by the employment impacts from COVID. With economic impacts expected to improve throughout the year, we expect Specialty Benefits premium and fee growth to return to 6% to 9% in 2022. Turning to capital on Slide 5. We ended 2020 at a very strong capital position with $2.9 billion of excess and available capital and with better clarity of the potential impacts from credit drift and losses. We're targeting $1.4 billion to $1.8 billion of external capital deployments in 2021, including $600 million to $800 million of share repurchases. And we continue to target a 40% dividend payout ratio. We expect the RBC ratio to trend down toward our 400% target as capital is deployed and the impacts from credit drift and losses are realized. We have a lot of momentum as we start 2021 and are confident in our diversified business model. We're well positioned to execute on our strategy and continue to create long-term value for shareholders. Before we open the call for questions, Dan has a couple of additional comments to share.

Thanks, Deanna. We're in an incredibly dynamic environment, constantly facing new challenges and taking on new opportunities. Principal has had a long history of adapting and evolving to meet the needs and demands of our expanding global customer base, while creating long-term value for our shareholders. As we announced earlier this week, we'll be completing a strategic review of our business mix and capital strategy. This is a continuation of the enterprise strategy work that's already been underway at Principal. This review will ensure we remain well positioned for continued growth, long-term value creation and future success. As we have in the past, we'll consider the entire spectrum of options to enhance shareholder value, meet the needs of our customers and strengthen our position as an industry leader. This effort will be led by the Finance Committee of our Board of Directors with the ultimate decision-making authorities sitting with our full Board. We're also adding 2 new members to the Board of Directors during 2021. Maliz Beams brings industry expertise to our Board and is joining the Finance Committee. We are confident she will provide valuable perspectives as we carry out our strategic review and ongoing board activities. A second director will be added to the Board by the end of the third quarter as part of our succession planning process. The strategic review will be completed in the coming months with a plan to announce the results at our Investor Day in June. With that, operator, please open up the call for questions.

[Operator Instructions] And your first question will come from Ryan Krueger with KBW.

I have a question on the strategic review, not surprisingly. I guess as you go forward with this, how do you plan to approach the trade-off between attractive third-party business valuations for some of your businesses, but comparing that to kind of your -- how those businesses fit with your strategic priorities that you've had?

Yes, Ryan, I really appreciate that question. And frankly, that's at the heart of the issue, isn't it? When you think about it, our business model historically been created to serve the needs of our customers in a very comprehensive way, and the work site has proven to be a good place to do that. And we focus on the work site, business owners and key individuals. And our ability to manufacture products that meets the needs of each one of those constituencies has really been important. And having said that, there's a lot of different ways you could get there as you think about how you might have other partners on your platform as we do today. And so the idea of the strategic review is really something that's ongoing for us. It's something we do on a constant basis. We have to be cautious and very thoughtful about how we deploy our capital. We need to make sure we look at all the various options. But the last thing we want to do is in any way destroy or undermine our value proposition to our customers. I'd also go on the record to say that a lot of our distribution partners value our -- the manner in which we go to market, whether it's group benefits or group retirement, how we distribute our mutual funds. Our large institutional distribution partners sell the full spectrum of our products. So as you might expect, this is a bit of 3-dimensional chess as we think about how we navigate it, but we will be very thoughtful. Having said that, there is the backdrop that in the last year, there's been a number of transactions that have been favorable and sort of liberating capital. And we want to make sure that we're looking at all those for its potential. So that's where we're at today, Ryan. But I appreciate the question.

The next question will come from Humphrey Lee with Dowling & Partners.

My first question is to, I guess, follow up on Ryan's question a little bit. You talked about kind of asset capture and kind of benefiting the different segments. Can you talk about like for -- across your segment, like what -- for your clients, like how much can RIS-Fee is kind of benefiting from Specialty Benefits relationship or PGI from RS? Can you maybe talk in terms of like for your clients, how many kind of different segments businesses do they kind of employ at Principal?

Yes. It's a more complex question than you might think on the surface because I'll start -- basically, think about this in 3 different categories. The first, as I mentioned earlier, is at the firm level. And so a lot of our products end up on the shelf at the firm level because of the relationship, and our relationships are deep and the names of those companies, some -- many of those are on the call today, and these are very valuable distribution partners, and they take great value in the fact that we can bring a comprehensive solution. Secondly, if you were just to distill it down to just group benefits and retirement, it's somewhere around that 15% range, give or take. And again, it recognizes that oftentimes, that was at the firm level and that advisors today parse the market. There's some that aren't properly licensed to sell the full gamut. But again, they bring in their partners. And so that's definitely a growth strategy. And then the last one and possibly the most important, as you think about the value of the relationship of the tens of millions of customers that we have here at Principal, it's a benefit event. When people are making decisions around retirement, they're making decisions about being a job changer, our ability today to provide comprehensive solutions to that individual, whether it's lifetime income and retirement, whether it's life or disability protection, those are all opportunities for us. And then, of course, the last thing I would mention is going back to core retirement and core group benefits. Most of those customers have more than one product. About 60%, as you know, have more than one pension product, DB, DC or ESOP. But also remember that one of our single largest TRS capabilities is nonqualified deferred compensation, and that is -- definitely ties right back to our life business. So the businesses are very much tied together. And as I said in my previous response to Ryan, there are other ways to solve that, but we have to be very careful and contemplative on how we do that, how we structure that. But again, it really does warrant, as it always has, taking a very close look is that the most capital-efficient way to deliver solutions to our customers. Humphrey, I hope that helps.

Yes, that helps. I appreciate that. My second question is regarding RIS-Fee and PGI, I guess what are your net flow expectations that are baked into the top line guidance?

Yes. Great question. Renee, you want to talk a little bit about RIS-Fee?

Yes, absolutely. So I'll approach it from a couple of different perspectives. The first is from a net cash flow in total for the fee business. We continue to be very pleased with the performance of the fee business. The pipeline is good, sales are rebounding from COVID. We have strong distribution networks in place. We have good underlying growth in plans and participants in recurring deposits. But as we look at 2021, we do see some noise in the system as a result of the IRT migration in. So remember, the business from IRT will begin to migrate in, in second quarter from a retirement perspective. And the other thing that is impacting here is the very strong equity market performance between 2020 and what is expected in 2021. And any time you have such an escalation in the equity markets, on a dollar basis, the withdrawals tend to look high. And so all things considered, we expect a flat net cash flow, but as you can see by our guidance, a strong revenue and earnings growth in 2021. I think the next piece of your question probably deals with what we anticipate seeing in terms of proprietary asset capture. And I would make a couple of comments there. First off, from a new sales perspective, Principal continues to be a leader in the marketplace in capturing proprietary assets. But if you take a look at the overall environment, we do see continued industry pressures on migrating from actively managed to a more low-cost passive investment, which, of course, puts pressure on the net cash flow that is ultimately driven to PGI.

Humphrey, hopefully, that helps.

Yes. What about PGI?

I'm sorry. Apologies. Pat?

Yes, Humphrey, this is Pat. I appreciate the question. So clearly, we're going to continue to build on the momentum that we established in 2020, Humphrey, in terms of our growth. I think we continue to believe we have some very viable, strong investment solutions that can be offered through our platforms and through our institutional clients. We have clearly a strong investment performance edict in terms of what we believe is a very desirable first and second quartile list of client activity that we look forward to developing as we go into 2021. And so our momentum should continue from 2020, and we expect that to be the case.

When I think, Pat, about your portfolio, you've got a lot of differentiated capabilities that still allowed you to maintain strong margins. Humphrey, thanks for the question.

The next question will come from John Barnidge with Piper Sandler.

It seems like you're leading up to $600 million of capital deployment available for some level of inorganic opportunities if you assume the high end of capital deployment and the low end of buybacks. Can you talk about where specifically you believe those opportunities lie?

Yes. Thanks, John. Appreciate that. And I'll throw that right over to Deanna.

Yes. John, just a couple of comments there. As you know, we came into the year with a very strong position. And you also noted that we've identified probably a higher-than-normal amount of external capital deployment for 2021 at that $1.4 billion to $1.8 billion. I think as we think about that range, and we're very comfortable with that range, I think it offers us a lot of financial flexibility around all the aspects of capital deployment, whether that be dividends, whether that be share buybacks or whether that be M&A. And so we'll assess the opportunities as we proceed through the year, continue to be balanced and disciplined, but we are comfortable with that range. Specific to M&A, our strategy has not changed. If you look at our past acquisitions, they have been focused more in the retirement, international or asset management space. We've had opportunities with many of our joint venture partners that we'll continue to take advantage of. And obviously, we'll continue to look at all items that we feel that will ultimately lead to long-term shareholder value and fit our strategic aspirations. And so I don't think our priorities have changed. And I think we'll continue to have flexibility and assess opportunities as they come our way.

John, a follow-up?

Yes. Thanks, Dan. Can you talk about which of your 3 most capital-intensive businesses, if you removed, would most impact distribution for your less capital intensive?

Yes. I don't have that in front of me right now. That's certainly one of the work streams for the Finance Committee of the Board to delve into that and truly understand all those inner workings. And as you might expect, these things evolve over time as well with these -- with distribution partners. And so there will be a really good opportunity when we get into the June time frame with the Investor Day to provide you with more insights and specifically answering your question, John. Hopefully, you can wait until then to have more clarity.

The next question will come from Erik Bass with Autonomous Research.

Maybe first, just a follow-up on John's question. In your press release announcing the strategic review, you talked about the capital deployment strategy being one of the items you would look at. Should we interpret this to mean that there could be changes to your current target for 2021 capital deployment and buybacks?

Deanna, you want to take that?

Yes. Sitting here today, we'll continue to assess that. And if anything changes, we will communicate that. If we're going to go around a strategic review that looks around our portfolio of business, the capital intensity of the business, that just naturally needs to then be married with if you are going to make any changes, how does that impact your capital deployment strategy. And so just us speculating on what came out of the review relative to our business mix, I don't think it makes sense to speculate on what might happen. But that's why they were both there. You really can't do one without the other.

Makes sense. And then maybe moving to the business. Can you give us some more color in terms of what's driving the Principal International outlook? I guess, specifically, could you separate some of the near-term items that are weighing on profitability with what you're seeing in terms of underlying growth trends?

Yes, it's a great question. And so maybe I'll hit on 3 areas and see if Deanna has some additional color. Note that Brazil has historically been a really strong contributor to growth and profitability, and it's a wonderful partner. But interest rates have plummeted in Brazil, and that's not been helpful necessarily for revenue and growth in that operation. The number of customer remains quite good. And we still enjoy about 1/3 of the market share and 1/3 of the flows, but it's in a different product set. Another area and I mentioned it in my prepared comments, Erik, and it was around Mexico. Mexico's compulsory program is going to have an increase in the next few years. It's going to, in large part, be borne by the higher cost of labor for employers. But the near term, we have downward pressure on the fee structures that we can charge. But as the compulsory percentages go up, we'll get that back, so kind of a short-term hit. And then long term, it creates more value for the franchise long term. From my perspective, if that means more residents in Mexico are better prepared for retirement, that's a wonderful trade-off. And then the last area is one that has more volatility to it, but it's in China. And again, the joint venture is very strong. And a lot of the flows that did come, which is, frankly, one of the reasons why we don't include it in our net cash flow number. A lot of those dollars were going into money market-like instruments. Some of that is now flowing to equities. And so we saw the fairly large outflows in the third and fourth quarter of 2020. And it certainly has a dampening impact on revenue generation for 2021. I'll throw it to Deanna, see if she has any additional insights on PI.