Thursday, May 11, 2006

BMO NB on Power Financial's Q1 2006 Earnings

  
BMO Nesbitt Burns, 11 May 2006

Power Financial reported fully diluted EPS of $0.55 versus $0.52 in Q1/05, our estimate of $0.57 and consensus of $0.59. Results were not surprising given the lower than expected results at Great-West combined with in-line earnings at IGM Financial last week. Pargesa reported another strong quarter in local currency, but these were somewhat offset by the negative impact of the rising Canadian dollar. As expected, the company announced a 7.5% increase in its quarterly dividend to $0.25 per share from $0.2325 per share. We expect another 4–7% increase in the dividend in Q3/06.

Power Financial remains Market Perform rated. Great-West contributes roughly 70% to the earnings of Power Financial, and we believe that 2006 is a transition year for GWO due to foreign exchange and uncertainty surrounding the future growth plans in the U.S. While growth expectations are more modest in 2006, Power Financial and its subsidiaries have a strong record of acquisitions and new strategic initiatives. Over the next 12 months, we expect dividend growth to outpace earnings growth in 2006, but that beyond 2006 earnings and dividend growth rates should be more similar. Given the lower earnings estimates for Great-West, slightly offset by higher earnings estimates at IGM Financial, as well as the results in the quarter, we reduced our 2006E and 2007E EPS to $2.50 and $2.85 from $2.55 and $2.90, respectively.

Power Financial’s share of its subsidiary earnings is presented in Table 1. The company’s share of GWO’s operating earnings rose 7% to $313 million in Q1/06 from $292 million in Q1/05. Overall, the results of GWO were shy of our expectations, as solid earnings in Canada were offset by lower earnings in the U.S. The company faces relatively modest earnings growth in 2006 given modest membership growth in the U.S., some additional expenditure on new systems as well as a strong Canadian dollar.

Power Financial’s share of IGM Financial’s earnings rose 11% to $103 million in Q1/06 from $93 million in Q1/05. Overall, results in the quarter were slightly ahead of expectations and the company continues to execute well. IGM is extremely well positioned from a strategic perspective in the Canadian mutual fund industry with multiple distribution capabilities, significant scale and a broad product offering that should generate reasonable net flows in most market environments. The company’s financial condition is exceptional and it is a prolific generator of free cash flow.

The contribution of Pargesa’s earnings declined 10% to $10 million in Q1/06 from $11 million in Q1/05. The decline is attributable to lower earnings at Bertelsmann and the negative impact of the strong Canadian dollar, which were somewhat offset by better results at Imerys. The better results at Imerys were attributable to strong sales results, slightly lower expenses, a lower effective tax rate and the positive impact of acquisitions.

Operating earnings at Power Financial available to common shareholders were $392 million, or $0.55 per share, compared with $365 million, or $0.52 per share, in the same quarter last year. Net dividend income to the holding company (i.e., dividends received from subsidiaries less dividends paid to common and preferred shareholders) is estimated to be roughly $12 million in the quarter.

Recommendation & Valuation

Power Financial remains Market Perform rated. Great-West contributes roughly 70% to the earnings of Power Financial, and we believe that 2006 is a transition year for GWO due to foreign exchange and challenges in U.S. health care. While growth expectations are more modest in 2006, Power Financial and its subsidiaries have a strong record of acquisitions and new strategic initiatives, and we expect dividend growth to outpace earnings growth in 2006. Given the lower earnings estimates for Great-West, slightly offset by higher earnings estimates at IGM Financial, as well as the results in the quarter, we reduced our 2006E and 2007E EPS to $2.50 and $2.85 from $2.55 and $2.90, respectively.

On a discount to current net asset value analysis, Power Financial shares trade at a 15% discount to net asset value, and our $36 target price represents a 16% discount to target net asset value
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