Monday, June 11, 2007

Foreign Exchange's Effect on Life Insurance Cos' Earnings

Scotia Capital, 11 June 2007


• Scotia Economics recently revised its f/x forecast.

What It Means

• We've decreased our EPS assumptions for GWO by $0.05 in 2007 and $0.01 in 2008, for MFC by $0.06 in 2007 and $0.07 in 2008 and SLF by $0.08 in 2007 and $0.08 in 2008. MFC is the most sensitive to f/x changes.

• Our new assumptions assume the C$ averages US$0.92 (was US$0.89) in '07 and US$0.93 (was US$0.90) in '08, £0.46 (was £0.44) in '07 and £0.47 (was £0.46) in '08 and ¥108 (was ¥96) in '07 and ¥101 (was ¥91) in 2008.

• Our GWO estimate assumes the Putnam deal, expected to close at the end of June, will be financed without common equity issuance, thus adding an additional $0.02 EPS in 2007 and $0.03 in 2008. This brings the total estimated EPS accretion from the deal to $0.03 this year and $0.07 next year, and, in our opinion, well short of the what we believe could be $0.13 accretion in 2008 (the "suggested" $0.08 plus $0.05 additional accretion by financing 100% of the acquisition in cash and debt and no common equity).

• Valuations for SLF and GWO look attractive here. SLF at 11x 2008E EPS and GWO at 12.4x 2008E EPS are 4% and 3% below their long term averages, respectively, relative to the sector. F/X weighs on Lifeco estimates

• Manulife is the most sensitive to f/x assumption changes, and the most sensitive to changes in the CAD versus the USD. Each 5% change in our f/x assumptions changes our 2008E EPS estimates by 4% for MFC, 3% for GWO and 2% for SLF (see Exhibit 1).

• Sun Life's long term EPS CAGR (from 2001-2008E), at 12%, is close to MFC's 13%, and its forward EPS CAGR (2006-2008E) excluding f/x, at 12%, is the same as MFC's (see Exhibit 2). This does not justify, in our opinion, the current forward P/E multiple spread, which at 13%, is twice its historical average (see Exhibits 3 and 4).