Monday, April 24, 2006

Merrill Lynch on Life Insurance Cos

The Globe and Mail, Roma Luciw, 24 April 2006

Merrill Lynch & Co. Inc. kicked off coverage of the Canadian insurance industry with a mixed review Monday, handing two of the biggest players — Manulife Financial Corp. and Sun Life Financial Inc. — “neutral” ratings on the basis of their valuation.

In a research note to clients, analyst André-Philippe Hardy said that Toronto-based Manulife has an attractive business mix with valuable Asian exposure, strong U.S. sales stemming from its takeover of Boston-based John Hancock Financial Services Inc., and a solid track record of earnings growth.

He noted, however, that at 14.8 times estimated earnings, Manulife's valuation is the richest among the four Canadian life insurance companies and high by global standards. Furthermore, Mr. Hardy said he does not think “further multiple expansion is likely, particularly since we believe Manulife is more exposed to weakening credit quality and currency fluctuations than its domestic lifeco peers.”

He has a $73.65 twelve-month stock target price on Manulife and a $48.93 on Sun Life, the other company he labelled “neutral.”

Mr. Hardy said that Sun Life's positives include its highly capitalization, large exposure to the asset-management business and to the attractive Indian insurance market, and a well-positioned domestic group platform.

On the downside, “the company's track record of embedded value growth is weaker than that of its two Canadian peers who provide disclosure,” it has greater exposure to deteriorating credit quality than some of its peers, and needs to improve its position in the key U.S. market, he said.

Sun Life stock trades at fourteen times this year's earnings and has a “relatively rich” embedded value, while prospects for further multiple expansion are limited, he said.

Mr. Hardy placed a “buy” rating on Winnipeg's Great-West Lifeco Inc. and Quebec City-based Industrial Alliance Insurance and Financial Services Inc., the smallest of the four Canadian insurance companies. He put a $33 stock price target on Great-West and a $38 target on Industrial Alliance.

Great-West stock has lagged its peers this year “on concerns that 2006 earnings will be hurt by currency fluctuations and by continued disappointing membership trends in the U.S. managed care business,” Mr. Hardy said, noting that the company's stock trades at a discount to Manulife and in line with Sun Life, despite having less exposure to weakening credit quality, industry-leading return on equity, and exposure to the high-multiple U.S. managed care industry.

Great-West operates in the U.S. annuity, group life and health care markets. According to Mr. Hardy, the implementation of new information technology systems in the U.S. health-care business during 2006 should improve Great-West's profitability, potentially place the company is a better position to seek new business and could lead to multiple expansion, Mr. Hardy said.

Industrial Alliance is “underappreciated,” he said, trading at the lowest valuation in the group. The company's earnings will benefit from the acquisitions of Clarington and the integration of National Life, and should not be harmed by the rising Canadian dollar.

Furthermore, Mr. Hardy said that Industrial Alliance has less exposure to deteriorating credit quality than Sun Life and Manulife and he believes the company will increase its market share of individual insurance and segregated funds.

Industrial Alliance “could eventually be a takeover target, in our view, given its smaller relative size,” Mr. Hardy said.

The company's size could hurt its group business — which represents about 30 per cent of earnings - because it is an area that is more dependent on size, he said. “Earning high returns on equity will be challenging, in our view, because market share is smaller in retirement services (a high-ROE business), while its most competitive product within that segment (insured annuities) earns a low ROE.”