Friday, August 08, 2008

Manulife Q2 2008 Earnings

RBC Capital Markets, 8 August 2008

Q2/08 core EPS of $0.66 was below our $0.78 estimate and the consensus estimate of $0.72.

• Three of the four core divisions were at or above expectations, with the miss mostly occurring in the corporate and reinsurance segments.

• This was, like Q1/08, 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 $0.19 to $2.70 in 2008 and by $0.05 to $3.30 in 2009 mainly to reflect the greater than anticipated impact of equity markets on the earnings of the company and also the weakness in equity markets thus far in Q3/08. Offsetting equity-related exposures would be a more accommodating currency environment if the Canadian dollar remains at its current level against the U.S. dollar.

• Our 12-month target price of $40 is down from $41, 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 11.8x NTM EPS, versus 9.4-11.3x for its peers and a 5-year average of 13.4x. 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 probable deterioration in credit quality and uncertain equity markets.)
Scotia Capital, 8 August 2008


• Top-line momentum continues. Once again a strong top-line, with individual insurance sales up 22% in the U.S. and 14% in Canada, segregated fund sales up 34% in Canada and U.S. variable annuity sales, while down 10% YOY over an excellent Q2/07 (competitors are down 20%), they were flat QOQ (competitors down 3%) suggesting modest gains in market share. In Japan insurance sales nearly doubled and variable annuity sales were up 139%. Hong Kong insurance sales were up 12% and Other Asia insurance sales were up 29%.

• No credit issues - a recurring theme with MFC. Sub-prime MBS exposure continues to decline, from $692 million at year end to $519 million (a mere 0.3% of invested, similar to Sun Life's 0.4% and significantly below U.S. lifecos at close to 4%), as a result of the combination due of the general amortization of mortgages, pre-payments and declines in market value. Since the majority of the sub-prime assets back policy liabilities, declines in market value do not impact income, as the liability is marked-to-market as well. MBS/ABS accounts for 5% of invested assets or about $8 billion, with 80% of the RMBS and 85% of the CMBS in 2005 and prior vintage. Net impaired assets hurt EPS by $0.015, but would have been $0.025 without the "assistance" of $23 million in pre-John Hancock merger assets, the benefit of which will likely not be recurring going forward. As well, the net impact of upgrades and downgrades in the bond portfolio results in a $50 million increase in actuarial liabilities ($0.02 in EPS) in the quarter.

• Weak equity markets hurt - but not nearly as much as Q1/08. The 11% weigthed average decline in equity markets QOQ in Q1/08 hurt EPS by $0.18. Q2/08 wasn't nearly as bad. The QOQ weighted average change in equity markets was 0.2%, resulting in no material increase in reserves for seg fund/variable annuity reserves, hurting growth in expected profit (which usually assumes 2% increase in equity markets per quarter), and consequently EPS, by $0.02. If we get a 10% jump in equity markets QOQ we could get an additional $0.12 in EPS.

• Company taking advantage of widening credit spreads to increase investment yields. The company maintains it is adding high quality asses at attractive spreads in this environment, and in the quarter added nearly $300 million in less than BBB bonds due to incremental investment activity, increasing its below investment grade bond portfolio to 4.8% of bonds from 4.4%. We take comfort from the fact that the increase was not due downgrades in the company's portfolio. As well, the company's track record of minimal impairments provides further testament.


• Even though no operational issues, a miss is still a miss - and it can hurt more when you're at such a premium multiple. We attribute the EPS "miss" of $0.03 versus our estimate and $0.05 versus consensus of $0.02 in a largely one-time tax related item and $0.01 in unusually poor mortality experience in the reinsurance division. As well, a host of items, that could be considered somewhat recurring also contributed, namely $0.02 in increase in credit provision in actuarial reserves (expected), $0.02 in larger-than-expected new business strain (could be sustainable if individual insurance sales continue at their torrid pace), nearly $0.02 in credit impairments (expected and could be somewhat sustainable in this environment), and $0.02 in lower-than-expected realized gains on surplus assets (lumpy, but somewhat expected given markets). Our Source of Earnings Analysis (see Exhibit 1) shows the reported EPS of $0.66 to be a relatively clean number, helped by $0.09 in the combination of experience gains in assumption changes (likely larger investment gains as the company takes advantage of widening spreads, as well as rising interest rates).

• Taking our EPS estimates down by $0.04 in 2H/08 and $0.09 in 2009 - to reflect the combined impact of tougher credit conditions and sluggish equity markets. The current quarter was likely negatively impacted by $0.03 due to credit and $0.02-$0.03 due to weak equity markets. We lowered our estimates given the difficult markets. Given no operational issues (the top-line momentum continues) we see no reason to lower the company's premier multiple. Could see $0.10 more in 09E EPS if C$ trade at US$0.95 versus our par estimate.
The Globe and Mail, Tara Perkins, 8 August 2008

Manulife Financial Corp. raised its dividend this quarter, even though profit came in below analysts' expectations, as the company remains optimistic a tough economy won't inflict too much damage on its operations.

The move underscored the insurance giant's confidence in its future, chief executive officer Dominic D'Alessandro said yesterday.

"I'm not particularly pleased to read, as I did this morning, the long litany of financial institutions coming forward with more and more problems," he said. "I don't manage those institutions; we manage our own ... and I think we're taking care of our affairs very well."

Toronto-based Manulife boosted its dividend by 8 per cent, to 26 cents a share, despite a 9-per-cent drop in profit to $1.01-billion.

"We look forward to continuing to deliver strong results in the periods ahead, no matter what the economic conditions are," Mr. D'Alessandro said. "Will it be 18-per-cent returns? Well, you know, that might be a little tough. But they'll be respectable returns."

Dividends in the financial services sector have been one of the casualties of a market crisis that's stretched on since last year.

Manulife's rival Sun Life Financial Inc., also of Toronto, which reported its financial results last week, chose not to raise its dividend this quarter. CEO Don Stewart said the company felt the decision was prudent in light of continuing economic uncertainty, and that it would take another look at its dividend rate "as the economic picture evolves."

However, dividend increases are far from extinct; Winnipeg-based insurer Great-West Lifeco Inc., for instance, raised its dividend by 5 per cent this quarter.

But some observers think they do appear increasingly endangered. In a recent note to clients about the Canadian banks' third quarter, which ended last week, Dundee Capital Markets analyst John Aiken asked whether 2008 could "be the year the dividend increases stopped?"

So far in fiscal 2008, only Toronto-Dominion Bank and Bank of Nova Scotia have announced dividend increases, he said.

"There are three banks that have the potential to go over a year without announcing a dividend increase in the third quarter," he said, adding it's "quite possible" that Bank of Montreal and Canadian Imperial Bank of Commerce will choose not to boost theirs. Neither bank has raised its dividend since the third-quarter of 2007.

"Even for those that do, we do not anticipate large increases, as the banks wisely try to conserve capital in the current, uncertain environment," Mr. Aiken said.

At Manulife, Mr. D'Alessandro told analysts to remember that "we don't run the business for quarter-to-quarter purposes, we run it for the long-term."

The insurer's share profit of 66 cents fell short of analysts' consensus forecast of 72 cents, as the company was hit by the effects of weak stock markets in the United States and Asia, as well as Canada's strong Canadian dollar and a rising tax provision.

Manulife's core earnings-per-share growth of 6 per cent was the worst of the four Canadian life insurance companies, RBC Dominion Securities analyst André-Philippe Hardy wrote in a note to clients.

But three of Manulife's four main divisions met or exceeded expectations, he said. The reinsurance operations and Manulife's corporate division - which was hit by lower gains on assets and private equity holdings, as well as the tax provision - pulled down the results.