Friday, September 28, 2007

RBC CM on Manulife

RBC Capital Markets, 28 September 2007

F/X drag and low interest rates should not negatively impact Manulife's target of 15% organic EPS growth. Manulife believes that it can reach its target of 15% organic EPS growth in the current environment as long as it achieves 10% year over year growth in Premiums and Deposits, which it views as possible now that Japan variable annuity sales have returned to previous levels. Manulife delivering on its objectives should be a positive for its shares. We are estimating 11% EPS growth in 2008, which is slightly below consensus estimates of 12%.

Credit issues in the US may be a catalyst for US insurance consolidation. If consolidation occurs, we believe Manulife is well positioned to make acquisitions in the US because: (i) Manulife's valuation has improved compared to US lifecos, currently trading at a 22% premium to selected US lifecos versus 6% in June 2007; (ii) Manulife has $3+ billion in excess capital that it can deploy for acquisitions; (iii) the rising Canadian dollar, versus the US dollar, makes potential US acquisitions larger; and (iv) Manulife would be able to generate significant synergies in most lines of business'.

Management was very positive on Q3/07 variable annuity sales results in Japan. We believe that Q3/07 Japanese VA sales results may top Manulife's previous best quarter of US$1.05 billion (Q1/06). Manulife's shares should react positively to an improvement in sales as sales had declined to approximately US$400 million per quarter since July 2006, when a key product was shelved for regulatory reasons.

Manulife is currently trading at 14.0x NTM earnings compared to its 5-year average of 13.1x and the current lifeco median of 13.0x. We believe that Manulife deserves the premium valuation it trades at compared to Canadian financial services companies and life insurers worldwide, based on the company's sales and earnings growth track record, excess capital holdings, growth prospects in Asia, and lower credit risk profile than U.S. lifecos and Canadian banks. Diversity of operations limits downside earnings risk and reserves appear conservative, with large provisions for adverse deviations relative to reserves and a track record of booking experience gains. The company remains well positioned if long-term interest rates increase.


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-year average forward P/E to reflect potential benefits from higher interest rates, rapidly growing value of new business, and potential for upward EPS revisions as our expected earnings growth 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.

Company Description

Manulife is Canada's largest insurer, with 45% of net income generated in the U.S., 36% in Canada and 19% in Asia. Manulife has delivered 12 consecutive years of record earnings growth, registering a 25% CAGR during that time frame, and is the fourth-largest life insurer globally as measured by market capitalization.