BMO Nesbitt Burns, 14 June 2006
Investment Thesis and OutlookManulife held its annual investor day on June 13, 2006. Overall, we believe the outlook for Manulife is unchanged: strong top and bottom line growth in the U.S. and Japan accompanied by continued expense gains and excess capital generation in Canada. We believe the company has at least $4 billion in excess capital and that it has been quite active in its share repurchase program over the last four to six weeks. We continue to expect 15%+ dividend growth from MFC over the next couple of years. Management reiterated its medium- to long-term EPS growth target of 15% and ROE target of 16%.
One clear message that came across during the presentations was the enhanced franchise value that is being created from the merger of Manulife, which provided operational discipline and accountability as well as product development, and John Hancock, which provided a very strong brand name. The beneficial combination shows up clearly in the earnings and business growth results, even analyzing growth in the businesses assuming they were combined prior to the acquisitions (Table 1).
Also noteworthy during the presentations was the company’s enhanced disclosure on the level of PfADs and the composition of PfADs. We applaud this move to crack open, ever so slightly, the “black box” of insurance. Of note is the fact that the relative level of PfADs after the JHF acquisition is higher than pre-JHF. While management ascribed most of the increase in PfADs relative to reserves to the recent strength in equity markets, we believe that the business mix at JHF required relatively higher levels of PfADs.
Manulife remains Outperform rated. In volatile markets, we believe that the shares of global franchises like Manulife are likely to perform relatively well. The company continues to enhance its franchises in North America and Asia and has the financial resources to drive organic growth.
Investor Day SummaryWe have summarized the important information from the investor day below.
United States• Combination of Manulife’s operating discipline, product development and distribution relationships with Hancock’s brand name is creating a formidable franchise. Over the last 12 months, Manulife has been the number one seller of life insurance in non-proprietary channels, up from a combined number four (MFC+JHF) prior to the acquisition. The company has also experienced similar gains in variable annuity sales. JHF’s neglected mutual fund operations have also been generating consistent net inflows and appear poised to have another strong year with the addition of GMO funds in June. While difficult to quantify, Manulife has experienced significant revenue synergies from the acquisition, which is unique in acquisitions in financial services.
• In individual life, the company continues to focus on broadening its penetration in new distribution channels resulting from the acquisition of JHF, particularly JHFN, the M Group and banks. While encouraged by Manulife’s strong sales performance over the last 12 months, it is not sustainable. We suspect that the company has carved out a top three (or five) position in terms of sales in the U.S. over the next few years. MFC is also introducing some new LTC products, which should help rejuvenate sales through this market over the next few years.
• In wealth management (annuities, mutual funds and 401(k)s), business momentum is good in all three segments. The company is moving “up-market” in the 401(k) from the micro-case level ($million, less than 250 lives) to $3–10 million range. The company continues to dominate the very small case market with over 1.4 million participants. In mutual funds, the company has revamped the product offering and increased the wholesaler force to 60 from 28. Net flows have been positive and in a positive trend since the acquisition, and the addition of GMO to the fund line-up should provide a unique new line-up of funds. At the time of acquisition, it was unclear whether MFC would keep the mutual fund operations but it appears that the economics and outlook for the business have improved sufficiently that it is likely to remain among JHF’s suite of products.
• In variable annuities, the company introduced a unique product with attractive withdrawal benefits that have sold extremely well. While products are important, the company has been very successful at nurturing new distribution relationships as a result of the combination with JHF. In all the major channels—banks, regionals, wirehouses, financial planners and JHFN—sales have increased at double-digit rates. Investors should not expect these sales results to be sustainable, as large competitors have introduced competing products that are likely to squeeze out some MFC sales.
Japan• Results from Japan remain on track to deliver another good year in terms of sales growth and earnings. In wealth management, the success of the BOTM-UFJ relationship continues to drive annuity sales and the company continues to foster new distribution relationships to mitigate its exposure to this one bank. In individual insurance, transplanted North American products adjusted to local customs continue to drive new business. The biggest challenge in Japan is to grow the professional career sales force. Bank deregulation in 2008 offers interesting potential to sell more insurance via bank branches.
Hong Kong• MFC operates an impressive business in Hong Kong, where it is number two in in-force life premiums and number two in the Mandatory Provident Fund (MPF) in terms of AUM. The key to growing insurance sales is to grow career agency and the company did add 200 agents in 2005. The real growth opportunity remains in wealth management given high savings rates and small competitors. Health insurance also appears to be a burgeoning market in Hong Kong. The company is hosting an Asia investor day on September 12, 2006, and we expect to get more details at that time.
Other Asian• Other Asian territories continue to experience high rates of growth, particularly out of China. The key to success is building a career sales force; however, the competition for qualified individuals is intense. While certain regions, like Indonesia, generate reasonable earnings, other areas, like China, are unlikely to generate material earnings over the next few years.
Canada• Earnings in Canada are reasonably well balanced between individual insurance, wealth management and group businesses. Most of the big three Canadian lifecos have experienced success in the DC market and all are introducing new products to entice retirees to roll over their DC plan assets into a life company annuity or other product. Manulife has been experimenting with different products and we believe that the insurance industry is well positioned to capitalize on this opportunity. Individual insurance continues to perform well and the acquisition of Maritime Life has given Manulife enhanced access to the MGA channel to complement its dominant position in the IDA channel. Pricing in UL remains competitive—a situation that is likely to persist for the balance of 2006. Manulife has experienced good sales growth in mutual funds and seg funds, particularly in income-type products. Overall, Canada is performing well and the oligopoly appears to be behaving favourably for investors.
Actuarial Review• One of the noteworthy events during the day was the presentation by the company’s chief actuary, Simon Curtis. Manulife disclosed that it has $26.5 billion in PfADs in 2005, up from $24.3 billion in 2004 and $10.6 billion in 2003 (prior to the closing of the JHF acquisition). Relative to general account reserves and segregated fund liabilities, the PfADs rose from 8.9% in 2002 to 10.0% in 2005. The rise in the ratio of PfADs to reserves reflects the positive impact of rising equity markets on reserves required on segregated funds.
• The company also compared the level of reserves in Canadian GAAP versus U.S. GAAP and cash surrender values. CGAAP reserves are $1.1 billion higher than U.S. GAAP reserves and exceed cash values on “surrenderable” policies by 14%. The company also showed the components of PfADs. As one would expect, PfADs on interest rate risks have increased (i.e. lower long-term interest rate assumptions require higher provisions), which were offset by lower PfADs on credit losses (this has been disclosed extensively by the company).
• What does all this mean? The added disclosure should provide investors with greater comfort as to the level of conservatism in the reserves and open a small crack in the “black box” of insurance accounting. We also have another theory. The new investment accounting rules expected on January 1, 2007 have the potential to increase earnings volatility (please see our report released December 14, 2005). Improving disclosure and the understanding of how earnings are released (PfADs are effectively future earnings) should help partially alleviate concerns on increased earnings volatility related to changes in investment accounting rules.
ValuationThe target price of $40 is unchanged, representing 14.4x 2007E EPS and 2.4x2006E BVPS, both in line with current trading multiples.
RecommendationManulife remains Outperform rated. The company reiterated its 15% EPSgrowth forecast over the medium to long term and a 16%+ ROE. There was nomaterial new information to impact our outlook on the shares. However, thecompany’s top and bottom line outlook remains robust in the U.S. and Japan.Results from Canada are expected to continue to generate good returns andprovide significant excess capital. We believe the company has been very activein its share buyback over the last month. MFC significantly improved itsdisclosure by not only providing the level of PfADs but also the composition ofPfADs. We applaud the company’s efforts on this front and encourage other life insurers to follow. In these volatile markets, we expect quality institutions likeManulife to perform relatively well. The company has significant excess capital,strong business momentum, growing franchises in the U.S. and Asia, and credit metrics are improving.
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• S&P Equity Research upgraded Manulife Financial Corp. from Sell to Hold. S&P says shares have slipped to our 12-month price target of U$31. S&P is encouraged by MFC's strong variable annuity sales and growing life insurance marketshare from its John Hancock operations. However, competition from banks remains a challenge for fixed annuity products, and a difficult interest rate environment could hamper earnings growth. S&P thinks MFC may benefit from future growth in Asia.
• Keefe Bruyette upgrades Manulife Financial from Market Perform to Outperform.
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Scotia Capital, 14 June 2006
Investor Day Highlights
• Manulife held its annual Investor Day in Toronto on June 13, 2006. As is usual for such events there was no significant new news. In opinion, the breadth and depth of the company's management team, its superior market positioning in growth markets globally, its solid topline growth and its conservative balance sheet and reserving practices continue to support an increasing premium multiple relative to the group. That said, unlike the group the stock has not "corrected" of late, pushing its premium to the group up from 3% to 6% (well beyond its 2% average, but not as high as its 8% peak we saw in 2002), while the others have fallen to discounts below their historical means. While we continue to believe a superior premium, above normal levels, is justified, we believe the likelihood of further significant expansion relative to the group is less likely, as we expect the recent exceptional EPS growth (17% in 2005, ex one-timers, and 16% in Q1/06), in part attributable to the John Hancock synergies, to return to a more moderate 13%-14% level, and the recent pace of the exceptional top-line growth to moderate slightly. We highlight several takeaways below.
• Strong management team - with significant breadth and depth. With a total of fourteen speakers from all divisions of the company, Manulife clearly showed the depth and breadth of its management team. The company definitely has the bench strength for what we believe to be a seamless transfer of duties if and when senior management step down. That said, we believe such an event is several years down the road. President and CEO Dominic D'Alessandro, at age 59, has a minimum of three years left to fulfill his promise of staying at the helm at least five years after the close of the Manulife/John Hancock merger.
• Not in Europe or South America because fully engaged in opportunities the company has in existing markets - likely to continue as such unless significant opportunity presents itself. On Europe, a market that is highly competitive and increasingly consolidating, D'Alessandro said its only entry would be to buy an existing insurer, and on South America, he noted the "promise is greater than the reality". A disciplined acquirer, we expect the company to stick to its current North American and Asian markets, unless a significant market shakeout presents an extremely attractive opportunity. On India, D'Alessandro cited displeasure with joint ventures as the largest deterrent (maximum ownership is currently 49%).
• Potential for more top-line growth in Japan in 2008, when deregulation will allow for banks to distribute life insurance products. Manulife's strong relationship with MUFG, its strategic partner for VA sales and the largest bank in Japan, continues to drive sales growth in the Japanese variable annuity market. The company continues to add relationships of late, including Nomura Securities, the largest security dealer in Japan, and Resona Bank and Saitama Resona Bank, the 4th largest banking group in Japan, and now has over 22 banks and security dealers selling its VA products. The company is extremely well-positioned when sales by banks are further deregulated at the end of 2007 to allow for the sale of life insurance products as well.
• Continued aggressive expansion in China - and with operations in 15 cities, has more licenses than any other foreign insurer. Management remains bullish about this market, where the company has nearly 5,000 agents (up from just over 3,000 two years ago) and has seen 43% CAGR growth in premiums and deposits since 1999.
• Exceptional U.S. VA sales growth likely to return to more "normalized" levels for Q3/06 and Q4/06. As we somewhat expected, management indicated that the 61%, 63% and 60% sales growth in U.S. variable annuity for Q1/06, Q4/05 and Q3/05 would likely not be sustainable, for two reasons. One, we are close to approaching a year following the May, 2005 launch of the Second Generation Product, the highly successful VA product that drove the growth, and two, other competitors have now copied the product to various degrees. We would expect the company to maintain market position and share (#2 in the non-proprietary channel) until its next new product launch, which we anticipate could be late 2006 or early 2007.
• #1 seller of individual life insurance in U.S., up from #4 pro-forma pre-merger - demonstrates the acquisition was indeed a revenue growth story. With strong and diversified distribution relationships, a superior product and superior brand (John Hancock), the company continues to ride the wave of expansion of brokerage in the U.S. individual life insurance market. With a focus on the older affluent market, the fastest growing market, and the brokerage distribution channel, the fastest growing channel (accounting for 36% of sales in 1983 and 60% in Q1/006), the company has climbed to #1 in the U.S. market, a market that overall traditionally grows in the 2%-3% range. While we continue to believe the company's sales growth will outpace the industry (MFC sales were up 78% in Q1/06 and 60% in Q4/05, versus the industry at 12%-15%) we have to believe that as the company's sales get larger the level at which the company outpaces the industry will subside to some degree.
• If we get another Katrina the hit could be in the $0.12-$0.13 per share range - the same level (spit adjusted) as last year. While the company has increased attachment points (from an aggregate one-time catastrophe loss of US$20 billion to US$30 billion before the company would pay a claim), and increased premium rates, a modest increase in capacity at the layer of coverage beyond the attachment point puts the loss for a Katrina-type hurricane at the same level as last year. However, should any one storm have total damages less than US$30 billion, the company's loss on its retrocession business should, in all likelihood, be zero.
• Conservative actuarial practices. The company updated its disclosure from two years ago as to the level of PfADs (provisions for adverse deviation) as a percentage of general account liabilities. Manulife's PfADs, traditionally in the 10%-15% range as a percent of general fund liabilities, have climbed from 14.2% in 2002, to 15.3% in 2003 and to 16.3% in 2005, despite the fact that the acquisition of John Hancock more than doubled the company's balance sheet liabilities. Simply said, the company's reserving practices are increasingly conservative, and remain at the high end of their historical range. The natural release of these PfADs is a large and sustainable driver of earnings and future earnings growth, and has consistently been 60%-65% of pre-tax earnings growth.
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Canadian Press, Rita Trichur, 14 June 2006
Manulife Financial Corp. continues to see plenty of growth opportunities abroad even as industry consolidation in Canada draws to a close, its chief executive officer said yesterday at an investor conference.
"Perhaps in Canada ... the consolidation is nearing completion but there are other developments in Canada that might be of interest in the periods ahead," said Manulife CEO Dominic D'Alessandro.
"I think in the United States there continue to be opportunities and I think, of course, in Asia the organic growth prospects are very, very good."
Asked to elaborate on the Canadian scene, Mr. D'Alessandro pointed to remarks he made last month at the company's annual meeting, advocating that financial institutions should be allowed to merge -- "whether bank with bank, bank with insurer, or insurer with insurer" -- largely without government restraint.
Mr. D'Alessandro -- who reportedly contemplated a combination with Canadian Imperial Bank of Commerce in 2002 -- said Canadians need to rethink the financial services industry.
"If you look at it and say, 'How might the financial services industry organize itself going forward?' you'd come up with a different set of scenarios, perhaps," he said.
"I don't want you to conclude from that somehow I'm lusting after acquiring a bank or merging with a bank -- that's not the case at all. I'm just saying that, perhaps, that ought to be a possibility that should be available."
The Conservative federal government has already said that dealing with the issue of big bank mergers, which have been off limits since 1998, isn't a priority.
In the meantime, Manulife considers Asia -- especially China -- to be the "new frontier" for growth.
The company has been opening new branches in China every couple of months, particularly in high-growth coastal areas, and is already in more cities than any other foreign insurer.
"There's still plenty of places for us to open in the next 20 years," said Victor Apps, senior executive vice-president and general manager of Manulife's Asian division.
"We'll keep growing on the branch expansion over the next few years from our current numbers . . . until we have 50 [to] 100 branches in China eventually, I'm sure," Mr. Apps said.
Chinese expansion is also a key priority for chief rival Sun Life Financial Inc., which also has a foothold in the world's most populous country.
For his part, Mr. Apps said Manulife is not influenced by its rival's moves: "The market is huge -- we all know that. The secret of China is to build the business well and profitably."
Its Asian division -- which also includes operations in Japan, Taiwan, Hong Kong, Indonesia, Malaysia, Philippines, Singapore, Thailand and Vietnam -- produced profit of $141-million (U.S.) in its latest quarter, representing 17 per cent of the total company's shareholders' earnings.
