Friday, May 05, 2006

Scotia Capital on Manulife's Q1 2006 Earnings

  
Scotia Capital, 5 May 2006

• 16% EPS growth (22% ex f/x), owing to strong sales growth, favourable investment results and the emergence of expense synergies. Results of $1.19 per share were $0.02 per share ahead of our estimate and $0.01 per share ahead of consensus. Excluding the impact of currency, which negatively impacted the company's YOY EPS by $0.07 per share, EPS growth was an impressive 22%. Over 62% of the company's earnings are from USD denominated jurisdictions, and 8% are from Yen denominated or Japan. With average quarterly levels of the USD down 6% YOY versus the CAD, and average quarterly levels of the Yen down 16% YOY versus the CAD, changes in currency changes took a substantial bite out of EPS growth. We expect this trend to continue as the CAD continues to appreciate versus the USD.

• Some noise as is usual for a company of this size - we put net impact at a positive $0.02. A company of this size and with all these segments will naturally have a lot of moving parts, and we don't believe investors should get too caught up in micro-analyzing quarterly movements that may appear to be one-timers in each segment. Nevertheless, we categorize "unusuals", all after tax, as a $19 million loss in the Corporate segment due to unfavourable claims in the discontinued John Hancock Accident and Health block, a $24 million gain in the reinsurance segment due to a downward adjustment on a previously conservative estimate for hurricane claims taken in Q4/05, a $32 million gain in the corporate segment due to refinements in asset cash flow segmentation in the company's U.S. fixed annuity business, an $18 million gain in the Japan segment resulting from lengthening the portfolio, $22 million in significantly lower than usual investment gains in the corporate segment, and $15 million (or just 1/4 of the QOQ decline in pre-hurricane experience gains) due to unfavourable claims experience in the quarter. All this nets to positive $18 million or about $0.02 per share. Even net of this, EPS growth was 14%, and 20% ex f/x.

• Moderate EPS reductions to reflect f/x - we still expect 15% (20% ex f/x) growth for the remainder of 2006 and 14% (15%-16% ex f/x) in 2007. We reduced our 2006 EPS estimates by $0.03 per share in 2006 ($0.05 if we include the $0.02 outperformance in Q1/06) and $0.03 per share in 2007 to reflect the negative impact of the strengthening CAD. We forecast an average rate of CAD/USD rate of 1.116 for the remaining three quarters of 2006 (or average levels of the USD down 7% versus the CAD), and 1.09 in 2007 (for a 3% decline in average levels versus 2006). Even with currency negatively impacting 70% of the company's bottom line to the tune of 7% in Q1/06, the company was still able to achieve a very respectable 16% YOY growth in CAD (22% ex f/x). For the remaining three quarters of 2006 we estimate the negative impact of currency will be 7% (relative to Q1/06, a weaker US$ offsetting stronger Yen), with an estimated 15% in EPS in CAD (20% ex f/x). In 2007 we estimate the negative impact of currency will be 3% YOY, and we look for 14% EPS growth in CAD (15%-16% ex f/x). We believe our 2007E estimate is conservative, and believe that should the company continue to grow in the 17%+ range ex f/x (in Q1/06 EPS growth ex f/x was 22%), and exceed our 15%-16% assumption ex f/x, there is a good chance the company can exceed our 14% EPS growth estimate (including f/x) in 2007.

• ROE at 16.3% up 220 bp YOY - with ROE back at company target and John Hancock acquisition complete, is it time for another acquisition? We expect company to remain patient, and buyback more stock. 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. We expect the company to increase its buyback activity, and gradually increase its payout ratio from its current 29% of 2006E to a level toward the top-end of its targeted 25%-35% range.

• 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 (VA) sales increased 61% YOY, gaining market share in this product category as the company refreshed its flagship optional withdrawal benefit, the Principal Plus for Life rider, available on its core VA product. Manulife's variable annuity sales growth was exceptionally strong, with heavy players such as Hartford, Prudential, and Met Life exhibiting growth rates of 0%, 49%, and 57%, respectively. The company now ranks second 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 78% YOY, with the company now ranking #1 in universal life sales, up from 3rd rank in 2004. Finally, 401(k) deposits increased 36% for Manulife, on the back of 15% growth 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.

• Earnings for U.S. division up 31% (ex f/x). Excellent sales growth and solid margin improvement in all segments contributed to the exceptional results for the company's largest division (44% of the bottom line in Q1/06). Maintaining this pace is obviously a challenge, and we expect sales growth to return to a more "normalized" 15% range with earnings up 15%-20% (ex f/x) through 2007.

• Earnings for Canadian division up 29%. Steady sales growth in Canada, management cites an irrational individual insurance market. Improving margins, the impact of rising equity markets, and favourable claims experience all contributed to an exceptional quarter. Citing an irrational universal life market in Canada, Manulife has made a conscious decision to not chase business. As a result, sales were down 4% in quarter. Variable products in individual wealth management continue to exhibit positive net sales, fuelling record gross sales of segregated funds. However, fixed products continue to incur net outflows in what was still considered a relatively low interest rate environment, in part due to the tremendous run in equity markets.

• Asia earnings up 13% ex f/x. Hong Kong led the Asian operations (ex-Japan), with 18% YOY increase in earnings in Q1/06 on a USD basis (operations are pegged to the USD), lead largely by excellent growth in wealth management sales and improved experience gains in the Hong Kong life business. Wealth management sales in this division more than doubled (up 107% YOY in USD) as the company launched new mutual funds and benefited from strong equity markets. In China, Manulife received approval for 2 new licenses and now has 14 licenses in China at the end of the quarter, which should contribute to strong sales growth in their Asian division.

• Japan earnings up 22% ex f/x and excluding "unusual items". Excluding the impact of a C$18 million gain in Q1/06 from lengthening the portfolio duration and a C$21 million net release of tax provisions in Q1/05, earnings for the company's Japan division were up 22% YOY ex f/x. Variable annuity sales in Japan hit the $1.1 billion USD mark setting a new record and were up 39% YOY ex f/x. as the company added three new banks and one security firm to their VA distribution network, bringing the total to 16 banks and 5 security dealers. As the company continues to expand its variable annuity distribution platform in Japan, and takes advantage of increased distribution points as its bank partner BOTM now has merged with UFJ (effective Q4/05) we expect the company to continue to build scale in this attractive market, and look for meaningful earnings impact in 2007 and beyond.

• Share repurchases continue at a robust rate with 3.5 million shares repurchased in Q1/06. Manulife repurchased 3.5 million shares in Q1/06 and a further 2.0 million shares in April. This 5.5 million share repurchase represents 0.7% of outstanding shares as of 2005 YE and 11% of their current 50 million share normal course issuer bid, which expires on 11/08/2006.

• Stock split - could be attractive to the stock's large retail. Manulife will pay a stock 100% dividend (effectively a 2-for-1 stock split) to shareholders on record as of May 25, 2006, payable on June 2.
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