Friday, February 11, 2011

Manulife Q4 2010 Earnings

  
Scotia Capital, 11 February 2011

Event

• The incremental cost of hedging more equity market and interest rate risk of C$0.08 per share garnered a disproportionate amount of attention compared to decent underlying trends in the business and the substantial reduction in risk exposure.

Implications

• We estimate base line run-rate earnings on a normalized basis of C$1.50 per share, including incremental costs of hedging and assuming no growth in 2011; when adding growth in the business, we lower our 2011 and 2012 EPS estimates to C$1.70 and C$1.93 from C$1.82 and C$2.15, respectively. Admittedly, we had factored hedging costs of C$300-$350M and higher earnings on surplus, now reconsidered given the cost of financial leverage and increased costs of hedging.

Recommendation

• The MFC stock got ahead of itself, in our view, in recent months, rising 35% since early December. We are lowering our 12-month PT to C$19, based on our new blended valuation model of 10x 2011E EPS (30%) and 1.25x BVPS (70%), which considers greater earnings stability, partially offset by lower ROE expectations. We would be more constructive closer to $16

Our main takeaways from the conference call include:

• We found it interesting that there was such an intense focus on the actual costs of hedging over the next few years, and little attention to the company being substantially ahead of plan in reducing earnings sensitivity to equity markets and interest rates. Through actions taken during the quarter, MFC decreased equity market and interest rate sensitivities by 43% and 18%, respectively.

• We expect the rating agencies to respond favorably to these developments, particularly when combined with early signs of fundamental improvement in the U.S. business, although we do not expect ratings upgrades until there is more evidence of the sustainability of these improvements and a demonstration of more stable earnings trends. Ratings upgrades could occur in late 2011, in our view.

• Our base line run-rate normalized earnings estimate of C$1.50 per share is based on calculations in Exhibit 1. We have revised our 2011E and 2012E EPS based on these estimates, which we believe to be conservative given they take into account more than the direct impact of equity markets and interest rates (C$933M). As such, we begin with adjusted earnings from operations of C$692 million.

• Sales results in Q4/10 were strong among the products that MFC has targeted for growth. Sales of individual life, travel insurance, and mutual funds posted records.

• In the U.S., the company made progress in sales of individual life products excluding universal life with secondary guarantees, which rose 14% in the quarter; John Hancock Mutual Funds recorded record sales for the year, at US$9.7 billion, and total AUM ended the year at US$98 billion.

• Sales in Asia rose 56% and reflected diversification of products and distribution channels throughout Asia, particularly in Japan and Hong Kong. The bank channel is becoming an increasingly important network, and MFC is making considerable progress in expanding relationships in this system.

• In terms of earnings, the most significant progress was seen in the U.S., where earnings before the impact of investment and market related experience gains more than tripled in the insurance segment and rose 14% in the wealth management business.

• Book value per share ended the year at C$14.23, an increase of 3% from Q3/10. The MCCSR rose 15 bp to 249%. Management suggested that, despite the improvements in the risk profile of the business, the substantial capital cushion, and improved macro environment, no action to redeploy capital will be taken until future capital regulations are clear, as requirements in many jurisdictions are under review.

• We expect ROE's of 11.3% to 11.5% in 2011 and 12.4% to 12.6% in 2012.
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