Friday, May 04, 2007

Manulife Q1 2007 Earnings

Scotia Capital, 4 May 2007


• Manulife reported Q1/07 EPS of $0.67, in-line with our estimate and $0.01 below consensus. We peg underlying EPS in the $0.65 range. EPS growth was 13%.

What It Means

• Once again, exceptional growth in the U.S. Fixed Products segment continues to drive growth - as this returns to average levels suggested by management, we see EPS growth decelerating to the 12% range for 2007 and 2008.

• Stock needs some earnings and sales momentum - unfortunately this wasn't the quarter for it. Sales in U.S. continue to disappoint. We believe multiple appreciation for Manulife is dependent on sales and EPS growth momentum, or perhaps an acquisition, none of which are on the immediate horizon. We see 12% EPS growth through 2008.

• While the 10% dividend increase was a pleasant surprise, we believe the focus will continue to be on organic growth, with no significant increase in buybacks or payout ratio.

• Reducing EPS by $0.02 for the remainder of 2007 and $0.03 in 2008 to reflect the earnings deceleration in U.S. Fixed products segment.

Q1/07 - Neutral at best

• $0.67 EPS. In-line with our estimate, $0.01 below consensus. We peg underlying EPS at $0.65. The company continues to benefit from excellent credit gains ("phenomenal" and "not sustainable", as per management) in its U.S. Fixed Products segment, where earnings where $0.03 per share higher than management suggested "guidance". This, combined with a $0.01 per share one-time gain related to a reduction of equities in the Japan in-force block of insurance business, and offset by unusually high claims experience in the company's Canadian group business ($0.02 per share), all in nets to a $0.65 underlying EPS.

• New accounting impact - a one time hit we back out - but net realized gains were as expected. The EPS excludes a $69 million (or $0.04 per share (fd)) charge for asset realignment under the new accounting rules, which are not a cash nor economical cost. The net realized gains on surplus assets, at $0.05 after-tax, were in-line with our expectation and in-line with what was normally amortized into earnings under the previous accounting method.

• Sales in the U.S. continue to disappoint - we believe positive momentum to sales growth is important for any multiple appreciation in the stock. Individual insurance sales in the U.S. were down 20% (after falling 10% in Q4/06). U.S. variable annuity sales were down 10% (after falling 9% in Q4/06 and falling 8% in Q3/06). Mutual fund sales in the U.S. were down 7%. The company claims that product re-pricing dampened Q1/07 U.S. individual insurance sales and as the playing field begins to level the company could regain some momentum. Some new minor product features the company looks to add to its VA suite might spark sales, but we remain cautious. Management somewhat talked down the potential impetus to VA sales growth from the new distribution arrangements with Morgan Stanley (wirehouse channel) and JP Morgan Chase (bank channel), suggesting it will take some time before sales through these new distribution arrangements make any sort of material impact.

• Stock needs some earnings and sales momentum - unfortunately this wasn't the quarter for it. We believe a catalyst for the stock, apart from an acquisition (which frankly we certainly don't see on the immediate horizon), will have to be sales growth and EPS growth momentum (which we didn't get this quarter). We see 12% EPS growth through 2008, and 10% excluding share buybacks. This 12% growth is the same as the average forecasted EPS growth rate for the Canadian lifecos (which are on average 7% cheaper on a P/E basis), and the same as the average EPS growth rate for our group of 10 U.S. lifecos (which are on average 7% cheaper on a P/E basis).

• 10% dividend hike was a pleasant surprise - we believe the company is perhaps now on track to provide 6%-10% dividend increases every 6 months, similar to SLF and GWO. With over $3 billion in excess capital and a bit of a slow down in share buyback activity (levels in the last six months, as a percent of EPS, were roughly one-half the levels we've seen in 2005 and 2006), we may in fact see Manulife move its payout ratio modestly up from 30% to the high end of its 25%-35% target range. We remain cautious though, as we've never got the impression from management that the target payout ratio range will substantially move.

• Once again, exceptional results in the U.S. Fixed Products segment continues to drive growth - as this returns to average levels suggested by management, EPS growth will likely decelerate. The company once again noted that earnings in the U.S. Fixed products segment (primarily spread-based business, about 1/3 of the company's U.S. earnings and about 15% of the company's bottom line), were unusually strong, and that, consistent with prior comments, it does not expect the segment's results to continue to contribute to earnings at this current level. With earnings of US$75 million per quarter indicated by management to be the expected average (along with a small amount of gains, which we estimate to be $10-$15 million) well below the US$133 million earned in Q4/06, and well below the US$140 million average over the last four quarters, we certainly expect earnings growth in the U.S. division to decelerate. Assuming earnings in the segment are in the US$90-95 million range per quarter through the rest of 2007 and all of 2008, we estimate earnings growth for the U.S. division to be 2% this year and 8% in 2008.

• Japan VA sales down 50% YOY. With Hartford (over twice the market share of Manulife in Japan variable annuity sales) recently releasing a new product in early 2007, we expect the level of competition in this market will remain intense. In addition, individual insurance sales continue to decline, down 4% YOY after declining 17% in Q4/06, declining 22% in Q3/06, and declining 22% in 2006. While earnings growth in Japan will benefit to some extent from growth in variable annuity assets, favourable markets, and a much improved investment climate, we believe a catalyst for the division could be a potential deal with Bank of Tokyo Mitsubishi (BOTM) to distribute individual insurance products via the bank's branches when the industry further deregulates at the end of 2007. We continue to watch this carefully, but remain somewhat sceptical as whether in fact this will happen (competition in Japan continues to intensify) and how it might translate into significant sales and earnings growth.

• Canadian division (down 8%) hurt by poor group insurance claims experience. The poor claims experience was in long term disability, which in our opinion can be quite volatile. Assuming the claims experience was unsustainable (a little aggressive in our experience) we put the Canadian division at 3% growth. Individual insurance sales were up 7% and individual wealth management sales were up 7%. We see this division as a 10% grower through 2008.

• Focus likely to continue to be on organic growth with no significant increase in buybacks or dividend payout ratio. When asked about acquisitions CEO Dominic D'Alessandro suggested that valuations are pretty high, and, with excellent credit and buoyant equity markets, there is no compulsion for others to sell. We get the impression this company prefers to wait for "blood in the streets", and, not seeing that now, will focus on its primary goal over the last several years, that of growing the business organically.
Financial Post, Jonathan Ratner, 4 May 2007

While both UBS and Desjardins cut their forecasts for Manulife Financial Corp. shares by $1 to $47 after the company’s first quarter results, they remain bullish on its prospects.

Jason Bilodeau says the possiblility of Manulife spending some of its $3-billion in excess capital on a meaningful acquisition could be a key catalyst, although this may take longer than expected given the lack of willing sellers, the UBS analyst said in a note to clients.

“MFC remains well positioned to compete in its key existing businesses with brand, product and distribution and we expect MFC to deliver strong results over time,” he said, adding that current the weakness for its shares present a buying opportunity.

Over at Desjardins, Michael Goldberg noted that insurance sales appeared to have plateaued for Manulife, with the value of new business there falling significantly.

However, he added that Manulife has indicated it expects an uptrend in coming quarters and does not feel an acquisition is needed to re-establish growth.
• Credit Suisse downgraded Manulife from "outperform" to "neutral." The 12-month price target is C$45.00 per share.

• Desjardins Securities reiterates its "top pick" rating on Manulife. The target price has been reduced from C$48 to C$47.

• UBS reiterates its "buy" rating on Manulife. The target price has been raised from C$46 to C$47.

In a research note published this morning, the UBS analyst mentioned that the company has a competitive advantage in its key existing businesses, in view of its brand, product and distribution. Manulife Financial is well positioned for making acquisitions going ahead on account of its C$3 billion in excess capital, a conservative leverage position and sufficient acquisition experience, the analyst wrote.
The Globe and Mail, John Heinzl, 4 May 2007

It seemed so small and insignificant that most investors probably missed it, among all the takeovers and market action. But yesterday, Manulife Financial did something magnificent, something truly sensational.

It raised its quarterly dividend by a whole 2 cents, to 22 cents from 20 cents.

"Two lousy cents!?" you say. "Who cares?"

You should care. Because Manulife, Canada's largest life insurer, offers a fine illustration of how even small dividend hikes can add up to big profits for patient investors.

Consider this: When Manulife went public, its first payout in 2000 was just 5 cents a share (adjusted for a stock split). Since then, it has raised its divvy no fewer than nine times, or roughly once every three quarters.

Most people are happy to get a raise of 5 per cent a year; Manulife has been raising its payout at a blistering 25-per-cent annual pace.

Now consider this: Had you bought Manulife when that first payout was declared and held the stock through all those increases, today the yield on your original investment would be more than 10 per cent. And here's the best part: The value of your stock would have soared 370 per cent.

Manulife is a shining example of why buying companies that raise their dividends regularly is a prudent strategy, particularly for investors seeking income and safety.

"Clearly, a higher dividend means more money directly in investors' pockets in terms of income," says Kate Warne, Canadian market strategist for Edward Jones & Co.

But that's not all. Rising dividends also send a strong signal about a company's financial health. "A company that's regularly increasing its dividend is clearly confident that it's going to have the cash to pay the dividends, not only today but in the future," she says.

Not all dividend growth stocks pay off as handsomely as Manulife, but studies show that, as a group, they handily outperform the market. And they do it with a lot less volatility because the dividend acts as a cushion during market downturns.

Edward Jones examined all TSX-listed stocks from 1996 to 2006 and found that companies that raised their dividends at least once a year returned an average of 19.8 per cent annually. That compares with 14.6 per cent for all dividend stocks (including those that raised their payouts and those that didn't) and a loss of 2.3 per cent for stocks that paid no dividends at all.

Not that dividend stocks are immune to the vicissitudes of the market. Even as Manulife raised its payout yesterday, the stock slipped 1.2 per cent after its first-quarter profit of 68 cents a share - excluding one-time items - missed analyst estimates by a penny.

But so long as the business remains sound, those sort of dips can present buying opportunities. The yield on Manulife's stock (which we own) tends to hover around 2 per cent, but based on the new dividend of 88 cents annually, the stock is now yielding an unusually rich 2.2 per cent. It's possible that the higher dividend will attract income-seeking investors, who will push the stock up and, in the process, bring the yield back down.

Plenty of other companies also raise their dividends regularly, including fellow insurers Sun Life Financial and Great-West Lifeco, pipeline operator Enbridge, electricity generator Fortis, clothing retailer Reitmans and all the major banks.