Monday, April 30, 2007

RBC CM Initiates Coverage of Great-West at Outperform

RBC Capital Markets, 30 April 2007


We are initiating coverage of Great-West with an Outperform, Average Risk rating on its shares.

Investment Opinion

• We believe relative multiple (or earnings) upside could come from rapid acceleration in earnings as a result of more favourable currency conversion rates, the integration of announced acquisitions, lower volatility in earnings from accounting changes and potential improvements in U.S. managed care results, as well as lower relative credit risk and exposure to equity markets.

• The European business, which accounts for just under one-quarter of profits, continues to perform well and we feel more upside potential remains.

• We believe that Great-West's share price is temporarily held back by the potential for a share issue to help finance the Putnam transaction. Management indicated at the time of the transaction announcement that it may issue up to C$1.2 billion in equity to finance the transaction, which is a short-term risk to the stock price. This risk is mitigated by our belief that Power Financial will likely subscribe for a large portion of the offer, and we believe that management will favour other types of financing options, if available, and issue less equity than the $1.2 billion figure.

• Valuation. Our 12-month price target of $40 is a combination of our sum of the parts and price to book methodologies. Our P/B target of 3.1x in 12 months is at the high end of our target for lifecos given a higher expected ROE than average (19.3% versus 14.7%). Our target P/E multiple of 13.5x 2008E earnings is in line with the company's 5-year average forward P/E to reflect potential benefits from recent acquisitions, a more accommodating currency and limited exposure to deteriorating credit quality. Offsetting those positives are uncertain equity markets and increased pressure on U.S. healthcare earnings.