Thursday, August 09, 2007

Manulife Q2 2007 Earnings

  
Financial Post, Grant Surridge, 10 August 2007

"This quarter demonstrates the strength of MFC's distribution capabilities, product innovation and brand quality, as sales rose in a number of key lines," wrote UBS Investment Research analyst Jason Bilodeau, who rates the stock a 'buy' with a 12-month target price of $47.

He thinks the stock has underperformed so far this year "amid broader weakness," but that it looks reasonably valued.
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BMO Capital Markets, 9 August 2007

Event

MFC reported Q2/07 operating EPS of $0.71 versus our estimate of $0.69 andthe First Call Mean of $0.69, and up 18% from a year ago.

Impact

Slightly positive.

Forecasts

Our 2007E EPS is unchanged at $2.80 and we reduced our 2008EEPS to $3.10 from $3.15 due to higher Canadian dollar (0.94 versus 0.90 in our priorestimates).

Valuation

We increased the target price to $45 from $44, representing 14.5x 2008E and inline with current 2007E P/E.

Recommendation

Manulife is rated Market Perform. Q2/07 results wereslightly ahead of expectations due to very good credit experience ($16 million in creditrecoveries) and strong investment gains. The company reported relativelymodest exposure to sub-prime mortgages of 0.5% of invested assets (discussedbelow). Despite concerns on credit, the company’s gross impaired loansdeclined in the quarter. Bonds rated below investment grade represent 4% oftotal bonds, which is the same level as prior to the Hancock acquisition. Sales results in Canada and U.S. wealth management remain strong and it appears thatVAs sales in the U.S. are accelerating. The company’s financial conditionremains exceptional, with at least $3 billion in excess capital and additionalleverage capacity to entertain large acquisitions. Manulife is unique amongCanadian companies, and North American life insurers, and should remain acore holding in any large cap portfolio. MFC did re-purchase 22 million sharesduring the quarter and we expect MFC to remain active in the buyback program.
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RBC Capital Markets, 9 August 2007

Q2/07 EPS Close to Our Expectations

Q2/07 fully diluted EPS of $0.71 compared to our $0.72 estimate and the consensus estimate of $0.70. Stronger equity markets and higher interest rates were important contributors to the core EPS growth of 22%.

• Earnings quality was solid as management changes in assumptions were again negative and the tax rate was higher than our estimate. Very strong growth in earnings on surplus funds allowed the company to grow net income by 15% in spite of relatively low (7%) growth in expected profit from in-force business, the largest and most important source of earnings (in our view).

• The Canadian and Asian businesses were ahead of our estimates, in spite of a 32% increase in individual life insurance sales in Canada (which we would normally expect to drive an increase in strain from new business). Experience gains were high in both divisions, buoyed by equity markets and investment returns.

• The Corporate and U.S. Wealth divisions were below our expectations. The U.S. Wealth business was negatively impacted by the non-recurrence of investment gains in the non-core John Hancock Fixed institutional portfolio and had unusually low experience gains given the strength of equity markets as both claims and lapse experience were unfavourable. John Hancock Fixed earnings of US$52 million were well down from US$154 million in Q2/06 and US$133 million in Q1/07 and closer to what management views as sustainable earnings (US$75 million).

• Manulife repurchased 21.9 million shares, at a cost of $867 million. The combination of the share buyback, dividends ($337 million), and the negative impact of currency on shareholders equity ($1.6 billion) drove book value per share down $0.94 to $16.21 sequentially.

• Management did not increase the duration of its North American investment portfolio as interest rates rose during the quarter. Manulife's earnings would benefit from a re-deployment of assets on an on-going basis (higher investment returns) and in the form of reserve releases (lower capital requirement from asset liability mismatches).

Sales Growth Accelerating

Year over year sales growth improved for insurance products (15% versus 1% in Q1/07) while sales growth of 4% in wealth management was in line with the 3% reported last quarter.

• Insurance sales growth was strong across the board, with the 12% growth in the U.S. contrasting sharply with the 12% decline seen in Q1/07. Manulife had increased prices earlier than many of its competitors as reinsurers raised prices, which led to a decrease in sales in Q1/07. Management attributed its better sales performance in Q2/07 to key universal life competitors increasing prices, as well as the introduction of two new universal life products. In Canada, individual insurance sales growth of 32% was best of the 4 publicly-traded Canadian lifecos, which management attributes to service enhancements and improvements in cycle time.

• Wealth sales growth was strong in Canada (19%) on continued success of the Income Plus offering, but it remained weak in the U.S. (1% growth) and Japan (4% decline). Sales growth should accelerate in H2/07 on the launch of new variable annuity products in the U.S. (May) and Japan (June), as well as easier comparisons.

• Value of new business was up 13%, driven mostly by the higher insurance sales. The Q2/07 value of new business represented a record for Manulife and is ultimately the best way to assess value creation from new sales in our view.

Credit Quality Remains Solid; Sub-Prime Exposure Appears Manageable

Q2/07 was another uneventful quarter from a credit point of view. Net impaired assets declined from 0.24% in Q2/06 and 0.21% in Q1/07 to 0.19% and the company had net recoveries on its income statement ($16 million). Manulife's exposure to U.S. sub-prime housing appears manageable. The company has $860 million in residential mortgage backed securities, representing 0.5% of invested assets. Management describes the assets as high quality and mostly of pre-2006 vintages and only 0.1% of the securities have suffered downgrades from rating agencies (although management stated that cash flow modeling drove investment decisions - not investment ratings. The company has no direct exposure to sub-prime residential mortgages nor sub-prime CDOs.

Currency negatively impacted book value

The negative impact on book value per share of currency translation was about $1.00 in Q2/07. Currency had a small impact on Q2/07 earnings compared to Q2/06, which should change in H2/07. Currency translation had a bigger impact on the Q2/07 book value than earnings because the book value is translated using end of period values. The Canadian dollar rose 8% against the U.S. dollar and 13% against the Japanese Yen during Q2/07. Assuming the Canadian dollar remains at its current level compared to the US dollar and the Japanese Yen, we would expect Manulife's H2/07 earnings growth to be negatively impacted by 4% due to currency translation. For comparison purposes, we expect Sun Life's H2/07 earnings growth to be negatively impacted by 3%, Great-West's by 2% and no impact for Industrial Alliance. (see Appendix 1 for summary of F/X rates).

We Continue to Believe Acquisitions are Likely

We continue to believe that Manulife is well-positioned to make an acquisition, for the following reasons:

• The revenue and expense benefits from the integration of John Hancock are mostly behind the company, and the capacity to integrate another acquisition is also higher now that John Hancock is mostly integrated. An acquisition, if as successful as the John Hancock one, would be positive for earnings growth.

• The acquisition of John Hancock significantly bolstered Manulife's product and distribution presence in what is still a very fragmented U.S. market. We believe that the company is better positioned than before to make acquisitions, with a larger market capitalization, a broader product lineup, better knowledge and a larger platform from which to generate synergies.

• We believe that an acquisition would be well received by most capital market participants, given the success of the John Hancock transaction. The company has historically been price-conscious when bidding for properties and has shown willingness to back out of competitive bidding scenarios, as it did with Canada Life and Altamira.

• We believe that the likelihood of larger acquisitions, if they occur, will be in the U.S. given the lack of sizeable targets in Canada and Asia (excluding Japan).

Valuation

Our 12-month price target of $47 is a combination of our P/E, price to book and embedded value methodologies. It implies an approximate forward multiple of 14.5x earnings, compared to the 5-year average forward multiple of 13.1x. Our P/B target of 2.9x in 12 months is at the high end of our target for lifecos given a higher expected ROE than average. Our target P/E multiple of 14.5x 2008E earnings is above the company's 5-average forward P/E to reflect potential benefits from higher interest rates, rapidly growing value of new business, a more accommodating currency conversion environment (even with the most recent increase in the dollar), and expected earnings growth that is below what the company has historically achieved and is targeting, partially offset by deteriorating credit quality, uncertain equity market performance and lack of benefits from transformational acquisitions. Our target multiple on embedded value of 2.0x is higher than for the other two Canadian lifecos, reflecting higher prospects for growth in value of new business, because of the company's positioning in Asia and the U.S.

Price Target Impediment

Risks to our price target include persistently low interest rates, deteriorating equity markets, adequacy of actuarial assumptions, acquisition/execution risk, unfavourable political and/or economic developments in Asia and appreciation in the Canadian dollar. To the extent that the appreciation in the Canadian dollar is due to improved bond yields, Manulife has a natural hedge to help offset its F/X drag due its asset/liability mismatch.
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The Globe and Mail, Tara Perkins, 9 August 2007

Executives at Manulife Financial Corp. are excited about the current tumultuous state of the markets.

"Nobody could be happier about what's happening in the general marketplace than our investment guys right now, because it's providing opportunities for us," the insurer's chief investment officer, Donald Guloien, said on a conference call yesterday.

He acknowledged that woes in the U.S. subprime mortgage market have been contagious.

Leveraged buyout activity has slowed, and the door has "basically slammed" on bridge loans, he said.

Even very high-quality, commercial, mortgage-backed securities that aren't related to the subprime market have seen spreads widen, he noted.

While some of Manulife's investments will likely fall a bit in value, the opportunities that are being created by the unfolding situation should more than make up for that, Mr. Guloien suggested.

"Unquestionably, there's some stuff that will get marked down in our portfolio on a mark-to-market basis over the coming quarters, but it will be very minor in amount and we're positioned to take advantage of the spread widening," Mr. Guloien said.

Manulife has been predicting for some time that spreads would widen out, he said. It has been shedding credit risk and positioning its portfolio, which is now "about as safe as it can be," he added.

"I just finished briefing our board and our ship's coming in," he said. "We're excited about what's happening. We see better covenants developing in the marketplace. There's lots we can take advantage of."

Manulife has $163.5-billion in invested assets.

Chief financial officer Peter Rubenovitch told analysts on the conference call that the insurer has no direct exposure to subprime-residential mortgages or subprime collateralized debt obligations.

The company does have $860-million of exposure to residential mortgage-backed securities related to subprime, he said. Those investments are high quality and the company says it does not expect any noteworthy credit losses related to subprime securities.

Manulife reported second-quarter profits of $1.1-billion yesterday, up 16 per cent from a year ago.

Diluted earnings per share were 71 cents, just beating analysts' forecasts of 70 cents per share. The insurer's total funds under management rose 11 per cent to $410.2-billion.

"The second quarter was a solid one for our company," stated CEO Dominic D'Alessandro.

He added that businesses in Asia are developing well. Earnings from the company's Asia and Japan division were $242-million in the quarter, up from $199-million a year earlier.

U.S. insurance profits came in at $179-million, up from $127-million. However, Manulife's U.S. wealth management business saw profits drop to $234-million, which was $67-million lower than the year-ago period.

Manulife's Canadian division saw profits rise from $267-million a year ago to $296-million in the recent quarter.

Stronger equity markets and higher interest rates were important contributors to the company's profit growth, RBC Dominion Securities Inc. analyst Andre-Philippe Hardy said in a note to clients.

He noted that the corporate and U.S. wealth divisions came in below his expectations. But the overall earnings quality was "solid," he said.
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Bloomberg, Sean B. Pasternak, 8 August 2007

Manulife Financial Corp., Canada's largest insurer by assets, said profit climbed 16 percent on higher sales in Asia and the U.S., where it owns fund manager John Hancock Financial.

Second-quarter net income was C$1.1 billion ($1.05 billion), or 71 cents a share, compared with C$948 million, or 60 cents, a year earlier, the Toronto-based company said today in a statement. It beat expectations of 69 cents a share, according to the average estimate of five analysts surveyed by Bloomberg. Revenue fell 11 percent to C$7.29 billion

Manulife joins Canadian competitors Great-West Lifeco Inc. and Sun Life Financial Inc. in recording higher contributions from businesses outside of Canada. The company received 48 percent of its earnings in the first quarter from the U.S.

``Obviously there's more volatility coming into their results,'' because of an increase in global business, said Gavin Graham, who helps oversee about $5.3 billion as chief investment officer at Guardian Group of Funds, including Manulife shares. ``I suppose that's the price you have to pay to get the higher growth opportunities outside of Canada.''

Shares of Manulife rose C$1.01, or 2.5 percent, to C$40.75 in 4:10 p.m. trading on the Toronto Stock Exchange. They've climbed 3.6 percent this year, compared with a gain of less than 1 percent among the 44-member Standard & Poor's/TSX Financials Index.

U.S. insurance earnings climbed 41 percent to C$179 million in the quarter because of gains from investments and an increase in premiums and deposits. The company said today that sales of long-term care products in the U.S. surged 61 percent to $58 million.

Chief Financial Officer Peter Rubenovitch told investors in June that Manulife is now ranked No. 1 in sales of individual life insurance.

Earnings at the company's Asia and Japan unit, where it gets about 18 percent of its profit, climbed 22 percent to C$242 million because of new products in Hong Kong and other regions. Profit from U.S. asset-management operations fell 22 percent to C$234 million, while Canadian profit climbed 11 percent to C$296 million. That compares with just 5 percent and 6 percent increases reported by Sun Life and Great-West Lifeco, respectively.

Profit in Canada and Asia were ahead of estimates, RBC Capital Markets analyst Andre-Philippe Hardy wrote today in a note to investors. Premiums and deposits rose 3.1 percent to C$16.4 billion, Manulife said.

Rubenovitch told investors today that Manulife has no direct holdings in the U.S. subprime mortgage market and that any risk was limited to C$860 million in a range of holdings in residential mortgage-backed securities. The company doesn't expect any ``noteworthy credit losses'' related to subprime mortgages, Rubenovitch said.

Manulife's target of 15 percent earnings per share annual growth is ``probable'' if the company continues to sell more U.S. life insurance, asset-management products and increases premiums and deposits, Genuity Capital Markets analyst Mario Mendonca wrote in a note to investors last month.

Manulife is the last of Canada's three biggest insurers to report earnings. Last week, Sun Life said second-quarter profit climbed 15 percent to a record C$590 million, or C$1.02 a share, while Great-West said earnings rose 17 percent to C$558 million, or 61 cents a share.
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