Friday, May 09, 2008

Manulife Q1 2008 Earnings

RBC Capital Markets, 9 May 2008

Q1/08 core EPS of $0.57 was well below our $0.73 estimate and the consensus estimate of $0.72.

• The quarter was disappointing, highlighted by greater sensitivity to equity markets than we expected. However, the causes of the miss should not be as detrimental to earnings in Q2/08 and beyond and Manulife continues to grow its core business.

• This was a disappointing quarter from a growing company operating in a tough macro environment, not a miss that causes us to conclude that the company is broken.

• We have lowered our estimated EPS by $0.15 to $2.95 in 2008 and by $0.10 to $3.35 in 2009 mainly to reflect the greater than anticipated impact of equity markets on the earnings of the company but believe that bottom line results will improve significantly in upcoming quarters versus Q1/08.

• Our 12-month target price of $41 is down from $42, reflecting our lower estimated EPS.

• We continue to rate Manulife's shares as Outperform based on the company's sales and earnings growth track record, excess capital holdings, and growth prospects in Asia. Diversity of operations limits (but does not eliminate) 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 to make acquisitions if attractive opportunities arise.

• Manulife's stock trades at 11.6x NTM EPS, versus 11.0-12.1 times for its peers and a 5-year average of 13.3x. We expect lifecos to trade at higher multiples in the medium term, but trading multiples could remain below the 5 year average for some time given the potential negative impact of lower interest rates, probable deterioration in credit quality, and uncertain equity markets.
Scotia Capital, 9 May 2008


• A significant miss. EPS was $0.57, well below our $0.73 estimate and consensus at $0.71, primarily due to weak equity markets.

• Volatility increases and earnings quality still difficult to decipher - CEO to step down. This, combined with the announcement that CEO D'Alessandro will step down May 2009, all suggests that MFC's valuation premium versus the group will more than likely continue to contract. Given potential management changes we expect no near term acquisition catalyst.

• Reducing EPS estimates by $0.09 in 2008 and $0.06 in 2009. The company noted the QOQ decline in equity markets (down 11% on a weighted average basis by geography) hurt EPS by nearly $0.18 in the quarter (most of which was reserve related as the company's variable/segregated business remains largely unhedged), suggesting the company would have reported $0.75, $0.02 above our estimate, had equity markets "behaved normally" in the quarter. Should equity markets continue their rebound since the end of Q1/08 (they're up nearly 8% QOQ using the same weighted average metric by geography) we expect we could likely get the majority of this back before the end of the year. That would imply we essentially leave our numbers unchanged. But instead we're reducing our EPS estimates by $0.09 in 2008 to reflect a lower level of gains in these tougher economic conditions (largely lower gains from private equities, alternative investments and "other assets") and a tougher credit environment.

• Source of Earnings Analysis suggests that outside of the negative impact of the equity markets, experience gains/assumption changes were exceptionally large, helping EPS more than normal, the extent to which may not necessarily be sustainable. Two items we can point directly to include changes in actuarial assumptions, which, when measured as a percent of actuarial reserves, were above their long term average, contributing an additional $0.03 to EPS, and an extraordinarily large 16% annualized return on "other assets", contributing an additional $0.03 in EPS over its usual 8%-9% yield. With the earnings release noting "favourable investment results" throughout several divisions, as well as good claims experience, as well as still very good credit experience, we believe there was likely an additional $0.03-$0.06 in other favourable experience gains, over and above the normal runrate, when measured as a percentage of actuarial liabilities. Obviously the equity market decline hurt EPS, likely by the $0.18 indicated by management. But the other "positives" helped EPS to the tune of $0.09-$0.12. Exhibit 1 includes our Source of Earnings analysis, where we suggest EPS was hurt by just $0.06 versus long term average. We believe the continued reliance on these experience gains to propel the bottom line will continue to lead to earnings volatility and earnings that may be construed to be of lower quality.


• Top-line momentum continues. Another great quarter in this regard, with U.S. individual insurance sales up 42%, U.S. variable annuity sales up 18%, and Canadian wealth management sales up 12%. Asia and Japan were strong. The company's ability to continue to expand distribution with an innovative product array is definitely its key strength.

• After a couple years of struggling Japan is up nicely. After having declining net income in 2005 and 2006 excluding the impact of currency, Japan's net income increased 23% excluding FX, despite difficult equity markets, with exceptionally strong sales growth (wealth management sales were up 77% and individual insurance sales doubled over a weak Q1/07).

• Poised for exceptionally strong 14% EPS growth in 2009. This could be much higher if in 2009 average equity markets appreciate above our 7%-8% expectation and the C$ continues to weaken versus the USD and the Yen. Manulife is the most sensitive of the Canadian lifecos to equity markets (a 10% change in equity markets, over and above our 7%-8% estimate could add an additional 8% to EPS growth), and the most sensitive to currency (a $0.95 Canadian dollar in 2009 versus our parity assumption could add another 4% to EPS growth).