Wednesday, August 01, 2007

Sun Life Q2 2007 Earnings

RBC Capital Markets, 1 August 2007

Investment Opinion

• Core EPS of $0.96 were ahead of our $0.94 estimate and in line with the street view ($0.96). Reported EPS were higher, but we exclude a $42 million ($0.07 per share) gain on an internal reinsurance transaction in Canada. Core EPS were up 20% over the weak Q2/06 results and in line with Q1/07.

• The quarterly dividend was increased $0.02 to $0.34 per share, a touch below our $0.03 expected increase.

• Quality of earnings was excellent this quarter with management actions and changes in assumptions of approximately ($43 million) on a core basis versus a gain of $60 million (i.e. a reserve release) in Q2/06.

• Value of new business growth of 10% on a trailing 12 month basis is positive on an absolute basis, but it is likely to trail the peer group's growth (IAG reported +22% growth).

• A major near term positive catalyst for earnings is the probable re-capture of strain related to Q4/06 and Q1/07 universal life sales in the U.S. We estimate the strain recapture will be between $80-$120 million (pre-tax), some time in H2/07. Near term risks to the Q2/07 earnings run-rate include: (i) currency translation in H2/07 if the Canadian dollar remains at current levels compared to U.S. dollar and British pound and (ii) likely unsustainable experience gains primarily related to equity markets and morbidity.

Investment Thesis

Sun Life is currently trading at 12.1x NTM earnings compared to its 5-year average of 12.0x and the current lifeco median of 12.9. Sun Life is highly capitalized, has exposure to large asset management businesses and has a well-positioned domestic group platform. Also, the company would benefit more than banks from rising interest rates, while it would be less impacted by deteriorating credit quality. The discount to Manulife and Great-West is justified, in our view. Sun Life's international platforms are less well established than Manulife's, while earnings quality and medium-term embedded value growth has been weaker. Compared to Great-West, Sun Life is more exposed to deteriorating credit quality and has less upside potential from recent acquisitions. Our 12-month price target remains $57, representing 16% potential upside including the dividend.
TD Securities, 1 August 2007

Impact – Positive

Headline operating EPS was $1.03, vs. our and consensus estimates of $0.97. However, if we back out a $42m (after-tax) reinsurance gain, operating EPS was $0.96, a penny shy of expectations. Other than the one-time reinsurance gain, we'd classify Q2/07 as a relatively clean quarter, with most of the themes playing out as we expected, and we go through the details below. We have raised our EPS estimates (see side bar); our price target goes to $59 (from $58); and, we maintain our BUY rating.


• Improved U.S. Life Insurance GAAP Earnings. SLF’s U.S. life insurance division’s GAAP earnings had suffered due to the lack of a proper funding structure (resulted in higher new business strain), an issue that is being rectified, and we saw improvements flow through in Q2/07. Earnings increased to $41m, vs. a loss of $4m in Q2/06. Also contributing to the yr/yr improvement was lower sales ($60m vs. $109m) - not a trend we’d like to see continue longer-term – and higher interest rates. Management has guided to slower U.S. life insurance sales in the coming quarters as producers’ transition to new product offerings.

• MFS had a Good Quarter. Earnings increased 28% (32% on a US$ basis); net margin was 34%, up from 27%; net outflows improved to US$121m, from US$341m; and, assets under management at quarter end were up 20% (to US$202b) – all on a yr/yr basis.

• U.S. Variable Annuity (VA) Sales showed Momentum. Gross U.S. VA sales were US$805m (and net inflows US$82m) vs. US$411m (outflows of US$277m) in Q2/06. This is the first quarter of net VA inflows in some time. The launch of its Income ON Demand VA contract, and ongoing initiatives (i.e., management changes and wholesaler expansion), are having a positive impact. We continue to believe that a more sustainable level of net inflows is still a year off as an old book of (single manager) business runs off, and competitors move into the “Income ON Demand” feature space.

• Canadian Earnings Increased 6%. Actually, earnings fell at this division by 3% if we exclude unusual items from both quarters. This is in line with our slower growth theme for Canada.

• Value of New Business Growth Tailed Off. Over the LTM, SLF’s VNB increased 10.1% over the prior year’s comparable period, a decent showing, but down from 13.2% growth at the end of Q1/07. While quarterly figures are not disclosed, we suspect VNB was down in Q2/07 vs. last year. Lower U.S. life insurance sales contributed to this softness; and, given management guided to slower U.S. life insurance sales over the next few quarters, we expect a similar showing in the second half of 2007.

• SLF repurchased 3m shares for $152m, and increased its dividend to $0.34 (from $0.32).

Justification of Target Price

Our $59 target price (up from $58) equates to 14.5x our four-quarter forward EPS estimate. We believe SLF offers the following positive attributes: (1) improving fundamentals in several key divisions; (2) strong recent performance / increase in the value of MFS; and (3) long-term growth prospects of its Asian operations.

Key Risks to Target Price

(1) Spikes in sales strain; (2) US$ weakness; (3) integration problems with the Genworth U.S. group business; (4) sudden spikes in interest rates; (5) significant downturns in equity markets; (6) poor mortality or morbidity claims experience; (7) regulatory investigations into industry sales practices; and (8) declining interest rates.

Investment Conclusion

We believe SLF’s shares have come under pressure over the past 6-months due to concerns regarding increased strain at its U.S. life insurance division, a result of new product launches, and the lack of a proper funding structure, which skewed results under Canadian GAAP (no impact on the economics of the product). As well, general noise in SLF’s results has caused investors to question the quality of its earnings. A few items provide us confidence with our BUY rating:

• A proper funding structure should alleviate new business strain at its U.S. life insurance operation.
• Accretion benefits from recent acquisitions in Asia / U.S.
• An innovative U.S. VA product has resulted in strong sales (and we expect earnings improvements).
• MFS is starting to gain momentum.
• Attractive relative valuation.

While there will always be noise in life insurance results, the magnitude of this noise could dissipate or be overshadowed by positive events over the coming few quarters. That said, if the C$ continues to strengthen (against the US$ and GBP), and equity markets decline (by our estimate, just over 50% of SLF’s earnings are derived from wealth management), we will have to revisit our EPS estimates, with a downward bias.
Bloomberg, Sean B. Pasternak, 31 July 2007

Sun Life Financial Inc., the first Canadian insurer to report quarterly earnings, said profit rose 15 percent to a record, topping analysts' estimates, as higher stock prices lifted asset-management fees. The stock had its biggest one-day jump in almost a year.

Second-quarter net income climbed to C$590 million ($557 million) or C$1.02 a share, from C$512 million, or 88 cents, a year earlier, the Toronto-based insurer said today in a statement.

Canada's third-largest insurer benefited from higher fund sales as the benchmark Standard & Poor's/TSX Composite Index climbed 5.6 percent during the quarter. Sun Life owns 36.5 percent of CI Financial Income Fund, the country's second- biggest mutual fund company, and has a stake in asset manager McLean Budden.

``Equity markets have been strong,'' said Ian Nakamoto, director of research at MacDougall, MacDougall and MacTier Inc. in Toronto, which manages about $4.2 billion, including Sun Life shares. ``When the markets go up, people usually put money into their mutual funds.''

Excluding one-time costs related to scrapping the Clarica brand in Canada and buying the U.S. group benefits unit of Genworth Financial Inc., profit was C$1.03 a share. That compares with the 96-cent-a-share median estimate of 10 analysts polled by Bloomberg.

Shares of Sun Life climbed C$1.34, or 2.7 percent, to C$50.39 at 4:18 p.m. in trading on the Toronto Stock Exchange, the biggest gain since Aug. 15, 2006.

Revenue dropped 28 percent to C$4.5 billion on lower returns from investment income. That was mostly because of changes in international accounting rules that reduced the value of the fixed-income portfolio, Chief Executive Officer Donald Stewart said.

``It's no longer what most people would regard as a solid indicator of the revenue received during the quarter,'' Stewart said today in a telephone interview.

Profit from Canadian insurance and asset management climbed 6 percent to C$280 million, boosted by sales of individual insurance and investment products. Mutual fund sales in Canada rose to an 11-year high in May, according to the Investment Funds Institute of Canada.

Earnings from MFS Investment Management, the company's Boston-based fund business, climbed 28 percent to C$68 million.

U.S. insurance earnings surged 73 percent to C$156 million on higher sales of annuities and individual life insurance. Sun Life reported last month that gross sales of variable annuities in the U.S. were at least $1 billion in the first five months of 2007, a 66 percent increase from the year-earlier period.

U.S. insurance results were ``well ahead of our expectations and one of the strongest quarters ever,'' UBS Canada analyst Jason Bilodeau wrote in a note to investors today.

Sun Life raised its quarterly dividend 6.3 percent to 34 cents a share, the fourth increase in two years.