Friday, February 09, 2007

Sun Life Q4 2006 Earnings

Scotia Capital, 9 February 2007


• Sun Life reported Q4/06 with $0.94 EPS, $0.01 above our estimate and $0.01 above consensus.

What It Means

• Another steady quarter, once again ahead of consensus. Excellent topline growth in the U.S. (insurance sales up 40%, variable annuity sales up 52%) is very encouraging, as is another solid quarter from MFS (earnings up 63%). We believe the compelling valuation, combined with a new fresh look to the senior management team, and more quarters like these, should help the stock eat up some of its forward P/E discount relative to the group (which currently is 6%, versus its 2% average over the last three years).

• We've increased our EPS estimates by $0.02 in 2007 and $0.03 in 2008 to reflect better-than-expected margin improvement at MFS and strong results in both Asia and Reinsurance, offset to some extent by increased new business strain in the U.S. We've increased our target to $58 from $55.

Another good steady quarter - better than consensus

• Another good steady quarter - $0.01 above consensus. Sun Life reported Q4/06 with $0.94 (fd) EPS, $0.01 per share above our estimate, and $0.01 above consensus. After modest "misses" in Q1/06 and Q2/06, the company has now reported two straight quarters modestly surpassing consensus (Q3/06 was $0.02 per share above consensus), which, when combined with the solid top-line growth and very encouraging results from MFS, should help the stock "catch-up" in terms of valuation relative to its peers, namely Manulife and Great-West Lifeco.

• Strong momentum in top-line growth in the U.S. continues. The distribution arrangements established earlier this year with the M Group and National Financial Partners (two large and well-established distributors in the U.S.) are certainly bearing fruit in terms of top-line growth in U.S. individual insurance, where sales were up 40% in Q4/06, after more than doubling in Q3/06 and Q2/06. U.S. variable annuity sales continue to gain momentum, with domestic sales up 52% in Q3/06, as the company continues to gain market share. We expect the trend to continue with a new product slated for a March 5, 2007 roll-out.

• Solid quarter from MFS. US$1 billion in net sales, margin improvement from 23% a year ago to 34% in Q4/06, and up from 30% in Q3/06 - MFS had another strong quarter. This has been an impressive story, and should continue to help drive earnings growth.

• Some noise, as is usually the case, but the reported number reflects the underlying growth of the company. In Exhibit 1 below we outline the variances versus our quarterly estimates by segment. As outlined in Exhibit 1, we believe a large portion of the better-than-expected results are due to recurring causes, such as MFS, where margin improvement is progressing faster than we anticipated, and Asia, where the integration and associated accretion of CMG is better than we thought, and Reinsurance, where mortality improvements and a very favourable pricing environment are producing higher margins than expected. On the other hand, we believe only about one-half to one-third of the "misses" by segment are recurring. In the U.S. Individual Insurance segment, a new funding arrangement, likely put in place in the next six months, should reduce the new business strain, the contributor of the "miss", by at least one-half. In the U.S. Annuity segment, at least one-half of the shortfall versus our estimate was caused by largely one-timers (reserve strengthening and credit reversals), with the rest due to diminishing reserve relief on GMDB reserves as markets improve (somewhat recurring). All in this nets to an additional $0.02 in EPS in 2007 and an additional $0.03 in EPS in 2008.

• Increasing EPS estimates by $0.02 in 2007 and $0.03 in 2008. As outlined above, our EPS estimate increase reflects better-than-expected margin improvement at MFS, higher profitability in Reinsurance, in what is apparently a much more favourable market than we originally anticipated, and better-than-expected accretion in the CMG acquisition in Asia. This is offset by increased new business strain in U.S. Individual Insurance (although an expected funding arrangement in the next six months should help alleviate this to some extent) and slightly lower than originally expected margins in U.S. annuity (largely due to the fact that the GMDB reserve hedge, while protecting the downside, does not yield an equal and offsetting earnings lift should equity markets improve).

• If the Canadian dollar stays at its current level versus US dollar through 2008 we could likely add $0.03 EPS in 2007 and $0.09 in 2008. We're assuming an US$0.86 Canadian dollar this year and US$0.89 next year, and each 5% change in our estimate is worth $0.09 or 2% of earnings. We forecast a 7% increase in yearly average levels of the S&P500 and the S&P/TSX in 2007, with Sun Life being more sensitive to changes in the S&P500. We estimate each 10% change in the growth rate for equity markets impacts our EPS estimate by approximately $0.20 per share.

• Multiple versus the group looking attractive - while valuation is certainly a "catalyst" a fresh look to the management team and 13% EPS CAGR through 2008 (ex f/x) should help. Sun Life is trading at a 6% discount to the average forward (NTM) P/E multiple of the Canadian lifeco group, well below its 3.5% average discount over the last seven years and its 2% average discount over the last three years. With what we believe a series of steady and consistent quarters, a fresh look to the management team, not to mention 13% average EPS growth through 2008 (ex f/x), close to the 14% we see for GWO and MFC, we believe the stock should "catch-up" to some extent in terms of its valuation relative to its peers.

• Canadian division (45% of bottom line) in-line with our expectation - up just 1% over exceptionally strong Q4/05 - we look for 7% growth through 2008 - in line with mid-to-high single digit target. The Canadian market continues to be very competitive, and, despite being on the verge of an oligopoly, the market is not behaving as such. While profitability is good (ROE is 15%) and the division is a key contributor to the company's excess capital (which currently stands at $1.5 to $2 billion), the Canadian division for Sun Life, in fact for all the large Canadian lifecos, is not the driver of EPS growth. We expect 7% growth in 2007 and 2008. Group businesses continue to be the bright spot, with exceptional sales growth and increasing profitability. Individual insurance sales, up 16%, continue to pace ahead of the market, but pricing remains very competitive.

• U.S. (23% of bottom line) - excellent top-line growth (likely sustainable) but weaker than expected bottom line due to significantly higher new business strain and reserve increases (mostly non-recurring by 2008). The individual insurance segment suffered to the tune of about $0.03 per share due to excessive new business strain that in the past had been offset by favourable funding of the U.S. AXXX reserves. In an effort to diversify the funding arrangement structure, the company chose to not utilize it for a large chunk of Q3/06 business written, and thus consequently suffered from the effect of sizeable new business strain on the large volume of business written in the quarter. We expect the company to have a new arrangement in place within the next six months, which will offset the strain issue. All in, most of the strain issue we saw in the quarter should be beyond us by 2008, and with a larger inforce block by then we expect renewed earnings momentum. The individual annuity segment was about $0.04 below our expectations, with about one-half that due to reserve strengthening and credit reversals (largely non-recurring). We expect the increasing new business volume (domestic VA sales up 52%) and significantly improving net sales to help this segment going forward. The Genworth group acquisition ($0.05 EPS accretion, largely in 2008) should add to the earnings momentum for this segment.

• We expect the company to continue to increase its dividend in the 7%-9% range every six months and buy back at least $500 million of stock annually. With a payout ratio at 32% of 2007E EPS, at the low end of the 30%-40% target, we expect the company to grow earnings faster than its EPS growth (which we forecast to be 12% CAGR through 2008, 13% ex f/x). We see further potential for tuck-in acquisitions from the $1.5 billion in excess capital and lots of buy-back support.
Bloomberg, Sean B. Pasternak, 8 February 2007

Sun Life Financial Inc., Canada's second-largest insurer, said profit rose for the fifth straight quarter, led by its Massachusetts Financial Services Co. mutual fund unit.

Fourth-quarter net income increased 14 percent to a record C$545 million ($460 million), or 94 cents a share, from C$478 million, or 83 cents, a year earlier, the Toronto-based company said today in a statement. Revenue rose 15 percent to C$6.14 billion.

Earnings from MFS, the Boston-based fund unit, surged 58 percent to C$71 million as higher stock prices boosted assets under management. The Standard & Poor's 500 Index climbed 6.2 percent in the quarter, leading to net sales of $1 billion at MFS, following three quarters of redemptions.

``We're very positive about the outlook for MFS,'' Chief Executive Officer Donald Stewart said today in a telephone interview. ``MFS is very well-placed on the international front.''

The shares rose to a record after profit topped analysts' estimates. Sun Life was expected to earn 91 cents a share, according to the average estimate of eight analysts polled by Bloomberg.

Shares of Sun Life rose 46 cents to C$51.92 at the 4:10 p.m. close of trading on the Toronto Stock Exchange. They've risen 5.3 percent this year, compared with a 2.2 percent gain for the Standard & Poor's/TSX Financials Index.

Sun Life said in October it won't sell part of MFS after earlier hiring investment bankers to find a partner. The insurer had considered an alliance with another firm after it had net redemptions from its mutual funds for nine straight quarters.

Stewart said MFS plans to add ``two to three dozen'' employees, such as research analysts, in foreign countries where it plans to boost distribution for its funds. MFS has about 2,000 employees worldwide.

``We want to expand our footprint in Australia, Asia and Europe,'' Stewart said today.

Canadian earnings rose 1.2 percent to C$257 million because of gains in its individual insurance business. U.S. insurance profit fell 35 percent to C$97 million because of lower annuities and individual life insurance earnings.

Profit from Asia more than quadrupled to C$33 million, bolstered by the company's year-earlier acquisition of CMG Asia Ltd. For the full year, profit climbed 7.5 percent to C$2.09 billion, or C$3.58 a share.

Stewart said he expects this year to meet Sun Life's ``medium-term'' goal of annual earnings per share growth of 10 percent. The company had 15 percent growth on a ``constant currency'' basis last year, according to an investor presentation.

Sun Life is the first of Canada's three biggest insurers to report results, with Manulife Financial Corp. scheduled for Feb. 13 and Great-West Lifeco Inc. on Feb. 15.

Sun Life increased its quarterly dividend by 6.7 percent to 32 cents a share. The insurer reiterated it plans to pay out 30 percent to 40 percent of earnings in dividends.