Friday, February 10, 2006

Scotia Capital's Comment on Manulife's Q4 2005 Earnings

• 17% EPS growth owing to strong new sales, excellent growth in in-force business, favourable investment results, and the emergence of expense synergies. 15.5% ROE, up from 14.9% in Q3/05, 14.3% in Q2/05 and 13.0% in Q4/04.

• Significantly better-than-expected sales growth across all divisions, especially U.S. as Manulife continues to increase market share.

• Results include an unexpected one-time $0.10 hit from hurricane Wilma, offset by two $0.06 reserve releases, which we generally view as one-timers.

• 17% dividend increase is over and above our 10%-15% estimate.

• Modest $0.05 per share decline in 2006E estimate to reflect f/x.

Solid Q4/05

• Solid 17% EPS growth (ex integration costs), owing to strong new sales, excellent growth in inforce business, favourable investment results and the emergence of expense synergies. Results of $1.15 per share (ex one-timers) were in-line with our estimate and $0.02 per share ahead of consensus.

• Dividend increased 17% to $1.40 per share annually - greater-than-expected. We believe the better-than-expected dividend increase reflects the quality of the company's earnings and its strong excess capital position ($3.5 billion). The company last increased the dividend 15% when it released Q1/05 results. We expect the company to continue to increase the dividend more frequently than annually and at a rate slightly greater than its annual EPS growth rate through 2007 (which we estimate to be 15% including the impact of the 2005 hurricanes, and 13% excluding the impact of the 2005 hurricanes).

• Results include an unexpected one-time $0.10 hit from Hurricane Wilma, offset by two $0.06 reserve releases, one due to the movement to a less risky asset profile in Japan and another due to an annual review of actuarial assumptions. We do not view the reserve release to be unusual or material, especially given the total of $120 billion in actuarial reserves on the company's balance sheet.

• Strong earnings growth across all segments. Canada up 14%, U.S. up 22% (up 28% ex/fx), Asia up 61% (ex/fx) and Japan up 55% (ex f/x). Only exceptions were Reinsurance (6% of bottom line) and Guaranteed and Structured Financial Products (G&SFP), 7% of bottom line, a particularly volatile segment, where even excluding the hurricanes' impact, less favourable claims and investment experience contributed to a 15% combined decline in earnings for these segments (ex f/x). We expect all divisions to continue to be robust in 2006, with a rebound in the reinsurance segment, where we expect significant 20%+ price increases in the property catastrophe retrocession market to significantly improve earnings growth. We still however expect earnings for the de-emphasized G&SFP division to modestly decline 5%, and look for single digit growth in the corporate segment (which accounts for 14% of the bottom line, and is comprised of excess capital and other residual items), as the company's ever-increasing excess capital position (now at $3.5 billion) poses a drag on EPS growth in the current low yielding environment.

• We expect 16% EPS growth in 2006 (12% excluding the impact of the hurricanes), and 14% EPS growth in 2007. The negative impact of currency, from a $1.21 average exchange rate in 2005 to an estimated $1.135 rate for 2006, obviously poses the f/x drag on YOY growth in 2006 as was the case in 2005 and 2004. Our pick-up in EPS growth in 2007 reflects an f/x assumption in 2007 just modestly different from 2006 ($1.11 in 2007, versus $1.135 in 2006).

• 15.5% ROE, up from 14.9% in Q3/05 and 13.0% in Q4/04. It clearly has not taken long since the closing of the John Hancock acquisition (closed in April, 2004) for the company to get its ROE back up to its initially targeted 16% level. We expect the ROE to modestly surpass the 16% target in 2007.

• Exceptional sales growth in U.S. division - Manulife continues to increase market share. Manulife's sales growth is particularly impressive versus its U.S. peers. U.S. variable annuity sales increased 63% YOY, helped by a May, 2005 launch of a superior product, and an expanding and diversified distribution system. Manulife's variable annuity sales growth was more than double that of a group of 7 peers who have already reported Q4/05 results (namely Sun Life, Ameriprise, Nationwide, MetLife, Hartford, Genworth and Prudential). The company now ranks third in the non-proprietary channel in U.S. variable annuity sales, up from fifth at the end of 2004. Manulife's U.S. individual insurance sales increased 60% YOY, significantly better than the 8%-10% growth attributable to its U.S. peers. Finally, 401(k) deposits increased 10% for Manulife, and are up over 15% in 2005. Clearly the company is gaining share, and with diversified distribution channels and an excellent reputation as a strong product innovator, we expect the trend to continue.

• In Canada good sales growth, consistent with or slightly ahead of market in wealth management and group insurance, but losing share in individual insurance as company has made a conscious decision to not chase business in what is deemed to be an irrational market. Citing an irrational universal life market in Canada, Manulife has made a conscious decision to not chase business. As a result, sales were down 2% in quarter. Thus it appears the company is selectively choosing its segments in the Canadian market.

• Good top-line growth in Asia and Japan. Japan individual insurance sales were up 14% YOY ($US) and Japan variable annuities were exceptionally strong, up 91%. As BOTM and UFJ begin their merger, we expect sales in the segment to continue to be robust. Hong Kong and the rest of Asia were steady, with 26% growth in wealth management sales and 16% growth in individual insurance sales. As the company continues to expand in Asia in general and China in particular (it opened three new offices in China and received two additional city licenses, it is now authorized to operate in 12 cities in China, the most of any foreign life insurance company), we expect sales for Asia to continue to be robust.

• Lots of excess capital - provides ample financial flexibility - but with this kind of organic growth, who needs to make an acquisition? We believe the company, a disciplined acquirer, will be more than content to continue to spend a portion of its $3.5 billion in excess capital buying back stock and/or increasing its dividend. With this quarter's 17% dividend increase, the payout ratio is 29% of 2006E EPS, and with a target range of 25%-35%, the company has lots of room for further increases. Despite the fact that the John Hancock integration is complete, we get the impression that management is content to continue to grow organically, and take advantage of its expanding Asian platform.