Friday, May 04, 2007

Great-West Lifeco Q1 2007 Earnings

Scotia Capital, 4 May 2007


• Great-West Lifeco reported Q1/07 EPS of $0.57, in-line with consensus and $0.01 above our estimates. Results were clean, with "no noise" and earnings in each segment in-line with our expectations.

What It Means

• A good steady clean quarter with excellent top-line momentum (revenue premium was up 20%). General expenses, up 7%, were higher than historical trend, due to the addition of Met Life's U.S. Bancorp's 401(k) business (closed Q4/06), but lower QOQ. Given the company's track record we expect in this to decline to levels of 1%-2%, adding $0.02 to 2007 and $0.04 to 2008.

• We see potentially $0.02-$0.03 in 2007 EPS from yield enhancements to the Equitable payout annuity block brought in house in Feb 2007, with another $0.03-$0.04 in 2008.

• Assuming no common equity issuance to finance Putnam we could see an additional $0.05 in EPS over the $0.08 suggested accretion level. We have just $0.01 for Putnam this year and $0.04 in 2008.

Good clean quarter - in-line

• In-line. Results were squeaky clean, $0.01 above our estimate and in-line with consensus.

• Continues to be an excellent revenue growth story. Overall revenue premium was up 31% or 20% excluding reinsurance), building on the 25% increase in Q4/06, and the 18% and 14% increases in Q3/06 and Q2/06 respectively. While Europe is certainly a driver (revenue premium up 35% ex f/x, U.S. Financial services was up 37% and Canadian individual wealth management sales were up 16%. We expect the momentum in each of these mentioned segments to continue, especially in Europe.

• Excellent cost control. General expenses, up 7% YOY were higher than the normal run rate due to the recently (Q4/06) closed 401(k) acquisitions U.S. Bancorp and Met Life, however they are down from a 9% YOY increase in Q4/06. Excluding the additional expenses associated with the Met Life and the U.S. Bancorp acquisition operating expenses were flat YOY. Given the company's track record, we would expect general expenses growth to return to levels consistent with the long term trend of less than 5%, if not closer to 1%. We expect the company to achieve a similar metric by the end of Q3/07, which we believe would result in an additional $0.02 in EPS in 2007, and $0.04 in 2008 (already in our numbers).

• Putnam financing. Once again, the company remained fairly tight-lipped on the call, mentioning they are still examining options, and that the deal is still expected to close sometime in Q2/07. We believe there is an increasing likelihood that there is no equity deal, a scenario whereby we could see an additional $0.05 in EPS accretion over and above the $0.08 in EPS accretion we see if the company is able to achieve its targeted margin improvement. We have conservatively adjusted our EPS numbers by only $0.04 in 2008 (and $0.01 in 2007) to reflect Putnam. Simply said, there is a great deal of potential additional EPS.

• Europe/Reinsurance (30% of the bottom line) continues to be the growth driver, with earnings up 21% (ex f/x). Sales in Europe were up 35% (ex f/x), better than expected, as the company continues to exhibit strong sales growth in U.K. payout annuities, group products in the U.K., and single premium savings products in U.K., Ireland and Germany. We expect earnings growth to continue at a 21% rate through 2008 for two reasons. One, operating leverage will continue to significantly increase, as the company has been able to keep expenses flat despite the revenue growth. Two, the company recently brought in house over $3 billion in payout annuity assets from the Equitable Life purchase in 2006. We expect yield enhancement on this block to contribute $0.02-$0.03 in EPS in 2007, with $0.03-$0.04 in 2008 and beyond.

• Canada (45% of the bottom line) - steady quarter up 10%. Earnings in Canada were in-line attributable to good sales momentum, good claims experience, favourable equity markets and good cost control. Individual insurance sales continue to build momentum, up 4% in quarter, after increasing 29% in Q4/06, and 19% in 2006. Individual wealth management sales were up 16% in Q1/07, building on the 23% increase in Q4/06 and the 18% increase in 2006. We forecast 10% annual earnings growth for this segment through 2008.

• U.S. (25% of bottom line) in line. The U.S. healthcare business (9% of the bottom line) showed encouraging results with earnings up 4% (after declining 11% in 2006) and membership up 8% YOY and remaining flat in what can be a very competitive Q1. This is the best Q1 net retention record we've see for this segment in the last 8 years. The Met Life 401(k) and the US Bancorp 401(k) acquisitions closed in the Q4/06, and brought with them US$16 billion of assets. Incremental expenses associated with the block, of which US$24 million or $0.02 EPS, which will largely disappear by the end 2007, pushed expenses up 10% YOY for the U.S. division, and held earnings growth back to a 5% level for the Financial Services Segment (16% of the bottom line), despite the 7% growth in gross profit and the exceptional 37% growth in financial services revenue and 30% growth in Financial Services assets (all helped by the acqusisition). Combining cost saves as the incremental expenses disappear when the business is put on GWO systems, as well as the additional fee income from these assets, and the additional distribution capacity (the company said it has kept all the Met Life wholesalers), we expect this segment to grow in the 15% range going forward,
• Desjardins Securities reiterates "buy" rating. Target price is reduced from $40.75 to $39.25.