BMO Capital Markets, 4 August 2006
Bearing the Burden of High Expectations
At 14.5x 2006E EPS, Manulife trades at a premium to every other large cap financial services company in Canada and its peers in North America. We believe that the premium is justified. We believe that MFC can grow EPS, organically, by roughly 15% annually over the next 3 to 5 years. We also do not believe that there are many other large capitalization North American financial services companies that can match this organic growth outlook. Clearly, extended equity market weakness would jeopardize this outlook but in that event, we suspect that MFC shares should perform relatively well. Given its premium valuation, MFC bears “the burden of high expectations”. This burden is highlighted by the equity market’s reaction to Q2/06 results where the share price fell 1.4%.
Manulife reported Q2/06 fully diluted EPS of $0.60 compared with $0.54 in Q2/05, our estimate and consensus of $0.60. The improved results were driven by continued growth in in-force business, good credit experience, better margins on new business in U.S. and Canadian insurance, and taxes, which were slightly offset by weaker equity markets, somewhat unfavourable claims experience and the rising Canadian dollar. These results do include $27 million, or $0.02, net gain on changes in corporate tax rates in Canada. Arguably, MFC earned $0.58 in the quarter, which is shy of consensus estimates of $0.60.
However, we believe that the market also reacted to the decline in the CTE Level on segregated fund guarantees to 68 from 73 in Q2/05 and 76 in Q1/06. Canadian life insurers are required to maintain CTE Level’s in the 60-80 range. To maintain a steady CTE Level of 70, an insurer would have to strengthen reserves in declining markets and decrease reserves in a rising market, holding all other variables constant. Had Manulife kept the CTE Level constant in Q2/06, earnings would have declined $107 million on a pre-tax basis and an estimated $0.05, or $80 million, after-tax.
We believe that there are three important points to remember when making this analysis. First, equity markets have retraced a significant amount of the lost ground since the end of the second quarter, which would increase the CTE Level. Second, analyzing the positive impact of a lower CTE on earnings in isolation ignores other parts of the business. For example, earnings in corporate and reinsurance, which we would consider less desirable earnings, were $54 million below our expectations. There were other less favourable items. Third, Manulife is a very large, diversified organization that, in any given quarter, should have a number of unusual items that may or may not be offsetting.
We believe that this type of discussion misses some of the more important trends within the organization, including:
• Business Growth: New sales and premiums & deposits all report strong increases in the quarter, particularly in the U.S. and parts of Asia. New business embedded value rose 46% in Q2/06 to $486 million.
• In-Force Profits rose 14% in the quarter to $776 million. On a constant currency basis, in-force profits rose 18%. These are very robust growth rates for in-force profits and indicate that the sales growth mentioned above translates into higher earnings.
• Despite sales gains, strain from new sales fell 25%. Margins on new business are higher than in previous years and are also reflected in the growth in new business embedded value discussed above.
• ROE continues to improve – 16.3% annualized in quarter
• MFC repurchased $0.9 billion of shares in Q2/06. While this level of buyback activity is not sustainable, we do believe that the company will remain active.
• Earnings growth from Asia and Japan remained very attractive at 59% in US dollars and 51% in Canadian dollars. The company continues to rapidly expand its distribution reach in all jurisdictions. Variable annuity sales in Japan are likely to be soft in Q3/06 as it launches some new products at the end of the quarter.
• Excess Capital. Despite returning over 100% of earnings in the form of dividends and buybacks in the quarter, MFC is likely to continue to build its excess capital position. The company has a history of prudent acquisitions (JHF and Japan). We believe the company maintains significant financial flexibility to make an acquisition.
Our investment thesis and Outperform rating remain unchanged on Manulife. The acquisition of John Hancock continues to deliver cost and revenue synergies. As well, the acquisition solidified the company’s position as a top three operator in Canada and among the top competitors in the U.S. insurance market. Manulife’s Asian operations, including Japan, offer long term organic growth opportunities that are second only to AIG among global insurers. With excess capital and a history of successful acquisitions, we believe that shareholders will be well rewarded in any future acquisition opportunities. Moreover, we expect dividend increases of 15%+ over the next 12-24 months. Our $40 target price remains unchanged, reflecting 14.5x 2007E EPS and 2.4x 2006E BVPS, consistent with current trading multiples.
U.S. Operations
Earnings in the U.S. Insurance division include individual insurance and long-term care (LTC) and weakened slightly to US$113 million in the quarter versus US$127 million in Q2/05. The decrease was attributable to lower investment income and lower mortality gains in JH Life. JH Life earnings declined to US$85 million in the quarter from US$109 million in Q2/05 reflecting strong sales and improved new business margins, which were offset by weaker equity markets and less favourable claims experience. JH LTC earnings rose to US$28 million from US$18 million in Q2/05 due to growth in in-force business and unusual charges last year that did not recur.
JH Life sales increased to US$190 million in Q2/06 from US$142 million in Q2/05, with growth across all product lines and distribution channels, which has resulted in market share gains (Table 2). We believe the sales results highlights the strength of Manulife’s distribution capabilities in the U.S., given the growth experienced across all distribution networks, particularly through the JHF network. As of Q1/06 (latest available data), JH Life sales ranked #1 in overall sales for the last twelve months, up from seventh position a year ago. Sales in JH LTC increased to US$36 million in Q2/06 from US$25 million a year ago, its fifth consecutive quarter of increased retail sales, which is attributable to new marketing initiatives, the addition of new distribution partners, combined with growth from existing sales channels.
In-force profit growth was 13% in US insurance – a robust result in a mature market – and sales strain was negligible in the quarter despite record new sales. Manulife continues to execute well on its distribution strategy in the U.S., which is encouraging; however, sales growth is not sustainable at these levels.
Overall, U.S. Wealth Management had another strong quarter, with earnings rising to US$268 million compared to US$199 million in the same quarter last year and US$221 million in Q1/06. The majority of the earnings growth is attributable to favourable investment results in Institutional Fixed products, higher fee income, and the beneficial impact of lower CTE levels discussed above.
Variable products contributed US$114 million to segment earnings, up from US$88 million a year ago. Net flows for JH variable annuities continued to be strong at US$1.4 billion this quarter, compared to US$896 million in Q2/05 and are flat from the previous quarter (Table 2). Strong VA net sales reflect new products introduced last year as well as the expanded distribution networks from the JHF acquisition. Manulife remains a top net seller of variable annuities and is gaining market share, ranking second from the fourth position a year ago. We believe VA sales are unsustainable at these levels longer term as competitors roll-out similar products. However, MFC has demonstrated an ability to continually drive new sales.
Earnings in JH Retirement Plan Services (small case 401(k)) rose to US$36 million from US$23 million in Q2/05 and US$31 million in Q1/06 due to good asset growth. Assets rose 25% to US$39.4 billion versus US$31.6 billion in Q2/05 and are up 1% from Q1/06. We believe this is an area that Manulife would like to make a large acquisition.
JH Mutual funds recorded strong net sales of US$719 million in the quarter, up from US$74 million in the same quarter last year and are down slightly from US$779 million in the prior quarter. As at June 30, 2006, mutual fund assets under management were US$30.5 billion, up from US$27.7 billion a year ago due to stronger sales and equity markets, combined with the expansion of the wholesaler sales force. Results in the mutual fund operations have improved dramatically since the acquisition and we expect to see further improvement in 2006.
We believe that the success of the JH mutual fund operations represents a window into the success that Manulife is having in reinvigorating the Hancock brand. Prior to the acquisition, John Hancock mutual fund operations had consistently reported quarterly net redemptions for five years. Since Manulife took control of these operations, it has revamped the product offering and sales force with dramatic results.
In the JH Fixed Products Group, which includes both retail and institutional, earnings rose to US$154 million from US$111 million in Q2/05 due to strong investment related gains, including gains on the sale of pre-merger JH Institutional assets of C$25 million, combined with favourable investment experience. While investment gains are amortized into income, the company released reserves associated with these assets that were written-down at the time of acquisition.
Excluding this gain, earnings in the quarter would have been approximately US$132 million, still ahead of our expectations of US$100 million. Earnings from the JH Institutional segment can be volatile from quarter to quarter, and results in the quarter are likely not sustainable. Total funds under management were US$43.5 billion, down from US$47.8 billion in Q2/05, due to net outflows of US$1.1 billion as the company continues to de-emphasize JH institutional products.
Overall, we remain very encouraged by the U.S. division’s results, particularly in terms of sales and premiums and deposits. We are projecting roughly 38% growth in 2006 from solid growth in in-force business and wealth management.
Canadian Operations
In Canada, earnings were up 40% to $267 million versus $191 million in Q2/05. However, excluding a benefit of $42 million relating to the lower Federal taxes, earnings in the quarter would have been $225 million, representing an 18% increase from the prior year. Earnings were driven by continued in-force growth and improved margins, improved lapse experience in individual life and the favourable impact of asset mix changes on reserves. Premiums and deposits in this segment declined slightly to $3.27 billion from $3.33 billion in Q2/05. This reflects lower proprietary mutual fund deposits, reflecting investor preference for more competitive global investment options. In response to this change in investor preference, several new global funds will be launched in Q3/06.
Canadian individual insurance reported earnings of $115 million versus $58 million in Q2/05, and $80 million last quarter reflecting improved lapse experience and lower tax rate. Sales in individual insurance were flat at $57 million from Q2/05 and up from $56 million in Q1/06 (Table 3). Sales growth is relatively modest due to an increasingly competitive environment in Canada.
Wealth management reported a 23% increase in earnings to $76 million in the quarter from $62 million in the same quarter last year due to higher fee based assets and lower taxes. Sales declined to $880 million in Q2/06 from $1.2 billion last quarter and $1.0 billion a year ago (Table 3). The year-over-year decline is attributable to weaker sales of fixed annuities, which continued to experience net redemptions due to the current low interest rate environment, combined with lower sales of segregated funds. The decrease in segregated fund deposits to $33 million from $242 million a year ago is attributable to the closure of Manulife’s 100% guaranteed product. The company expects to launch a new segregated fund product in Q4/06 in order to revitalize sales in this segment. Manulife will also be introducing several new funds in Q3/06 to broaden its product line. Funds under management rose to $37.1 billion at June 30, 2006, from $33.2 billion at the end of Q2/05.
Earnings in the group businesses were $76 million compared with $71 million in the same quarter last year, driven by the positive impact of asset changes, which were somewhat offset by less favourable claims experience. Sales in group businesses can be lumpy and declined to $236 million in the quarter versus $338 million in Q2/05. Group Savings and Retirement Solutions recently announced a new large case sale to Rogers Communications and are expected to close in Q3/06. Premiums and deposits rose to $1.83 billion in Q2/06 from $1.77 billion in Q2/05.
Earnings in the Canadian operations continue to be well balanced between individual life, wealth management and group, and we would expect this balance to remain. We are projecting roughly 24% growth in 2006 and 10% growth in 2007.
Asian Operations
Earnings from Asia (excluding Japan) increased 26% to US$86 million in Q2/06 from US$68 million in Q2/05, primarily due to stronger earnings from the Hong Kong wealth operations. Earnings in Hong Kong increased to US$72 million from US$55 million in Q2/05 due to growth in its in-force insurance business and strong wealth management earnings resulting from higher fee income. Wealth management sales in Hong Kong increased in the quarter to US$318 million from US$116 million in Q2/05, largely due to higher sales in individual wealth management due to the introduction of new funds, good fund performance and improved local equity markets (Table 4). Insurance sales in Hong Kong for the quarter totalled US$28 million, down from US$30 million in Q2/05 and up from US$27 million in the previous quarter, reflecting a shift in sales towards wealth management products.
The core business remains its agency force, where the number of agents in Hong Kong rose slightly to 3,287 from 3,215 in the last quarter. Hong Kong remains the hub of MFC’s operations in Asia and we expect fairly modest earnings growth of 6% in 2006.
Earnings from all Asia territories increased slightly to US$14 million from US$13 million in Q2/05. While relatively small, these other Asian operations represent significant future profits. The number of agents in the other Asian territories increased in the quarter to 16,819 from 16,290 in the prior quarter, which is encouraging. We continue to believe the sales force is the key to long-term growth in Asia.
In the quarter, Manulife announced an agreement to acquire The Pramerica Life Insurance Company in the Philippines from Pramerica Financial. This is the fifth acquisition for Manulife in the Philippines, and we believe that the company will continue to build its position in this region.
Japan
Earnings from Japan were US$92 million in the quarter versus US$39 million a year earlier. The results include US$29 million in gains resulting from the lengthening of the asset portfolio duration on the Daihyaku block, which were partially offset by increased reserves, for a net benefit of C$16 million. Excluding this gain, results in Japan were strong, reflecting good mortality and expense and investment gains.
Sales in variable annuities totalled US$745 million, up 10% from Q2/05, reflecting the successful alliance with BOTM/UFJ. Manulife recently suspended sales of one of its VA products in Japan as it awaits clarification from the Japanese tax authorities regarding withdrawal benefits and the withholding taxes associated with those withdrawals. This particular product accounted for 30% of new VA sales in June and 14% of the segment’s segregated funds under management. Clearly this suspension is likely to impact sales momentum in the short term. However, the company plans on launching a new product in September, so the impact is likely to be modest. We expect VA sales in Japan to weaken in Q3/06 and then resume its growth path.
The agent network dropped to 3,684 from 4,075 in Q2/05, as the company continues to experience some challenges recruiting new agents and is proceeding with its initiatives to enhance agent productivity. Sales of individual insurance totalled US$23 million and are not comparable to prior periods due to a change in reporting methodology, where results from prior periods were not restated. Overall, results from Japan are very encouraging. With a distribution arrangement with BOTM/UFJ, MFC has emerged as one of the largest VA sellers in Japan. We continue to expect results in Japan to benefit from an improving macroeconomic environment and new distribution initiatives by the company.
Reinsurance & Corporate
Reinsurance reported a gain of US$43 million in Q2/06 up from earnings of US$24 million in Q2/05 largely due improved life reinsurance experience gains and improved underwriting margins in the P&C business, slightly offset by poor claims experience.
The corporate segment reported a gain of $18 million, down from $80 million in Q2/05 and $51 million last quarter. The decline is due to lower investment income, basis change charges related to the new reserves in Japan ($19 million pre-tax), the negative impact of corporate tax changes of $15 million on an existing deferred tax asset, partially offset by two arbitrated items that resulted in a net gain of $4 million.
Asset Quality, Capital & Buyback
Gross impaired loans declined by $180 million to $611 million from Q1/06 and similarly net impaired loans decreased by $127 million to $398 million from Q1/06. The decline was largely due the reduction of certain JHF products, like institutional spread-based products, which require more yield to meet targeted returns. We continue to believe the company’s asset quality and coverage are more than adequate. Provisions for future credit defaults in actuarial liabilities declined to $2.7 billion in Q2/06 from $2.9 billion in Q1/06. The decrease reflects the impact from currency and a reduction in below investment grade bonds, which have fallen from $6.9 billion in Q2/05 to $4.7 billion at the end of Q2/06.
Manulife’s main operating subsidiary, Manufacturers Life Insurance Company, had an MCCSR of 211% in Q2/06 versus 224% at the end of Q1/06. The John Hancock Life Insurance Company’s Risk Based Capital Ratio (RBC) remained stable at 359% over the same period. Manulife remains very well capitalized with over $3 billion in excess capital. The CTE level fell to 68 from 73 in Q2/05 and 76 in Q1/06.
The company repurchased roughly 25.7 million shares in the second quarter, which is significantly higher than our projections of 5 million shares per quarter.
Valuation & Recommendation
Overall, results in the quarter were quite good, with earnings growth well diversified across the company and solid sales growth across all segments. Pre-tax profits rose 12% and a lower tax rate helped drive earnings growth to 14% in the quarter. The company continues to benefit from steady earnings contribution from Canada, strong U.S. operations with cost synergies from the JHF acquisition, as well as a growing Asian platform. The company bought back 25.7 million shares in the quarter and with excess capital over $3 billion, ROE of 16.3%, and earnings growth of 15%+ in the medium to long-term, Manulife remains Outperform rated.
Our investment thesis and Outperform rating remain unchanged on Manulife. The acquisition of John Hancock continues to deliver cost and revenue synergies. As well, the acquisition solidified the company’s position as a top three operator in Canada and among the top competitors in the U.S. insurance market. Manulife’s Asian operations, including Japan, offer long term organic growth opportunities that are second only to AIG among global insurers. With excess capital and a history of successful acquisitions, we believe that shareholders will be well rewarded in any future acquisition opportunities. Moreover, we expect dividend increases of 15%+ over the next 12-24 months.
Given results in the quarter, we have adjusted our 2007E EPS slightly to $2.75 from $2.78 and our 2006E EPS remains unchanged at $2.43. Our $40 target price remains unchanged, reflecting 14.5x 2007E EPS and 2.4x 2006E BVPS.
Bearing the Burden of High Expectations
At 14.5x 2006E EPS, Manulife trades at a premium to every other large cap financial services company in Canada and its peers in North America. We believe that the premium is justified. We believe that MFC can grow EPS, organically, by roughly 15% annually over the next 3 to 5 years. We also do not believe that there are many other large capitalization North American financial services companies that can match this organic growth outlook. Clearly, extended equity market weakness would jeopardize this outlook but in that event, we suspect that MFC shares should perform relatively well. Given its premium valuation, MFC bears “the burden of high expectations”. This burden is highlighted by the equity market’s reaction to Q2/06 results where the share price fell 1.4%.
Manulife reported Q2/06 fully diluted EPS of $0.60 compared with $0.54 in Q2/05, our estimate and consensus of $0.60. The improved results were driven by continued growth in in-force business, good credit experience, better margins on new business in U.S. and Canadian insurance, and taxes, which were slightly offset by weaker equity markets, somewhat unfavourable claims experience and the rising Canadian dollar. These results do include $27 million, or $0.02, net gain on changes in corporate tax rates in Canada. Arguably, MFC earned $0.58 in the quarter, which is shy of consensus estimates of $0.60.
However, we believe that the market also reacted to the decline in the CTE Level on segregated fund guarantees to 68 from 73 in Q2/05 and 76 in Q1/06. Canadian life insurers are required to maintain CTE Level’s in the 60-80 range. To maintain a steady CTE Level of 70, an insurer would have to strengthen reserves in declining markets and decrease reserves in a rising market, holding all other variables constant. Had Manulife kept the CTE Level constant in Q2/06, earnings would have declined $107 million on a pre-tax basis and an estimated $0.05, or $80 million, after-tax.
We believe that there are three important points to remember when making this analysis. First, equity markets have retraced a significant amount of the lost ground since the end of the second quarter, which would increase the CTE Level. Second, analyzing the positive impact of a lower CTE on earnings in isolation ignores other parts of the business. For example, earnings in corporate and reinsurance, which we would consider less desirable earnings, were $54 million below our expectations. There were other less favourable items. Third, Manulife is a very large, diversified organization that, in any given quarter, should have a number of unusual items that may or may not be offsetting.
We believe that this type of discussion misses some of the more important trends within the organization, including:
• Business Growth: New sales and premiums & deposits all report strong increases in the quarter, particularly in the U.S. and parts of Asia. New business embedded value rose 46% in Q2/06 to $486 million.
• In-Force Profits rose 14% in the quarter to $776 million. On a constant currency basis, in-force profits rose 18%. These are very robust growth rates for in-force profits and indicate that the sales growth mentioned above translates into higher earnings.
• Despite sales gains, strain from new sales fell 25%. Margins on new business are higher than in previous years and are also reflected in the growth in new business embedded value discussed above.
• ROE continues to improve – 16.3% annualized in quarter
• MFC repurchased $0.9 billion of shares in Q2/06. While this level of buyback activity is not sustainable, we do believe that the company will remain active.
• Earnings growth from Asia and Japan remained very attractive at 59% in US dollars and 51% in Canadian dollars. The company continues to rapidly expand its distribution reach in all jurisdictions. Variable annuity sales in Japan are likely to be soft in Q3/06 as it launches some new products at the end of the quarter.
• Excess Capital. Despite returning over 100% of earnings in the form of dividends and buybacks in the quarter, MFC is likely to continue to build its excess capital position. The company has a history of prudent acquisitions (JHF and Japan). We believe the company maintains significant financial flexibility to make an acquisition.
Our investment thesis and Outperform rating remain unchanged on Manulife. The acquisition of John Hancock continues to deliver cost and revenue synergies. As well, the acquisition solidified the company’s position as a top three operator in Canada and among the top competitors in the U.S. insurance market. Manulife’s Asian operations, including Japan, offer long term organic growth opportunities that are second only to AIG among global insurers. With excess capital and a history of successful acquisitions, we believe that shareholders will be well rewarded in any future acquisition opportunities. Moreover, we expect dividend increases of 15%+ over the next 12-24 months. Our $40 target price remains unchanged, reflecting 14.5x 2007E EPS and 2.4x 2006E BVPS, consistent with current trading multiples.
U.S. Operations
Earnings in the U.S. Insurance division include individual insurance and long-term care (LTC) and weakened slightly to US$113 million in the quarter versus US$127 million in Q2/05. The decrease was attributable to lower investment income and lower mortality gains in JH Life. JH Life earnings declined to US$85 million in the quarter from US$109 million in Q2/05 reflecting strong sales and improved new business margins, which were offset by weaker equity markets and less favourable claims experience. JH LTC earnings rose to US$28 million from US$18 million in Q2/05 due to growth in in-force business and unusual charges last year that did not recur.
JH Life sales increased to US$190 million in Q2/06 from US$142 million in Q2/05, with growth across all product lines and distribution channels, which has resulted in market share gains (Table 2). We believe the sales results highlights the strength of Manulife’s distribution capabilities in the U.S., given the growth experienced across all distribution networks, particularly through the JHF network. As of Q1/06 (latest available data), JH Life sales ranked #1 in overall sales for the last twelve months, up from seventh position a year ago. Sales in JH LTC increased to US$36 million in Q2/06 from US$25 million a year ago, its fifth consecutive quarter of increased retail sales, which is attributable to new marketing initiatives, the addition of new distribution partners, combined with growth from existing sales channels.
In-force profit growth was 13% in US insurance – a robust result in a mature market – and sales strain was negligible in the quarter despite record new sales. Manulife continues to execute well on its distribution strategy in the U.S., which is encouraging; however, sales growth is not sustainable at these levels.
Overall, U.S. Wealth Management had another strong quarter, with earnings rising to US$268 million compared to US$199 million in the same quarter last year and US$221 million in Q1/06. The majority of the earnings growth is attributable to favourable investment results in Institutional Fixed products, higher fee income, and the beneficial impact of lower CTE levels discussed above.
Variable products contributed US$114 million to segment earnings, up from US$88 million a year ago. Net flows for JH variable annuities continued to be strong at US$1.4 billion this quarter, compared to US$896 million in Q2/05 and are flat from the previous quarter (Table 2). Strong VA net sales reflect new products introduced last year as well as the expanded distribution networks from the JHF acquisition. Manulife remains a top net seller of variable annuities and is gaining market share, ranking second from the fourth position a year ago. We believe VA sales are unsustainable at these levels longer term as competitors roll-out similar products. However, MFC has demonstrated an ability to continually drive new sales.
Earnings in JH Retirement Plan Services (small case 401(k)) rose to US$36 million from US$23 million in Q2/05 and US$31 million in Q1/06 due to good asset growth. Assets rose 25% to US$39.4 billion versus US$31.6 billion in Q2/05 and are up 1% from Q1/06. We believe this is an area that Manulife would like to make a large acquisition.
JH Mutual funds recorded strong net sales of US$719 million in the quarter, up from US$74 million in the same quarter last year and are down slightly from US$779 million in the prior quarter. As at June 30, 2006, mutual fund assets under management were US$30.5 billion, up from US$27.7 billion a year ago due to stronger sales and equity markets, combined with the expansion of the wholesaler sales force. Results in the mutual fund operations have improved dramatically since the acquisition and we expect to see further improvement in 2006.
We believe that the success of the JH mutual fund operations represents a window into the success that Manulife is having in reinvigorating the Hancock brand. Prior to the acquisition, John Hancock mutual fund operations had consistently reported quarterly net redemptions for five years. Since Manulife took control of these operations, it has revamped the product offering and sales force with dramatic results.
In the JH Fixed Products Group, which includes both retail and institutional, earnings rose to US$154 million from US$111 million in Q2/05 due to strong investment related gains, including gains on the sale of pre-merger JH Institutional assets of C$25 million, combined with favourable investment experience. While investment gains are amortized into income, the company released reserves associated with these assets that were written-down at the time of acquisition.
Excluding this gain, earnings in the quarter would have been approximately US$132 million, still ahead of our expectations of US$100 million. Earnings from the JH Institutional segment can be volatile from quarter to quarter, and results in the quarter are likely not sustainable. Total funds under management were US$43.5 billion, down from US$47.8 billion in Q2/05, due to net outflows of US$1.1 billion as the company continues to de-emphasize JH institutional products.
Overall, we remain very encouraged by the U.S. division’s results, particularly in terms of sales and premiums and deposits. We are projecting roughly 38% growth in 2006 from solid growth in in-force business and wealth management.
Canadian Operations
In Canada, earnings were up 40% to $267 million versus $191 million in Q2/05. However, excluding a benefit of $42 million relating to the lower Federal taxes, earnings in the quarter would have been $225 million, representing an 18% increase from the prior year. Earnings were driven by continued in-force growth and improved margins, improved lapse experience in individual life and the favourable impact of asset mix changes on reserves. Premiums and deposits in this segment declined slightly to $3.27 billion from $3.33 billion in Q2/05. This reflects lower proprietary mutual fund deposits, reflecting investor preference for more competitive global investment options. In response to this change in investor preference, several new global funds will be launched in Q3/06.
Canadian individual insurance reported earnings of $115 million versus $58 million in Q2/05, and $80 million last quarter reflecting improved lapse experience and lower tax rate. Sales in individual insurance were flat at $57 million from Q2/05 and up from $56 million in Q1/06 (Table 3). Sales growth is relatively modest due to an increasingly competitive environment in Canada.
Wealth management reported a 23% increase in earnings to $76 million in the quarter from $62 million in the same quarter last year due to higher fee based assets and lower taxes. Sales declined to $880 million in Q2/06 from $1.2 billion last quarter and $1.0 billion a year ago (Table 3). The year-over-year decline is attributable to weaker sales of fixed annuities, which continued to experience net redemptions due to the current low interest rate environment, combined with lower sales of segregated funds. The decrease in segregated fund deposits to $33 million from $242 million a year ago is attributable to the closure of Manulife’s 100% guaranteed product. The company expects to launch a new segregated fund product in Q4/06 in order to revitalize sales in this segment. Manulife will also be introducing several new funds in Q3/06 to broaden its product line. Funds under management rose to $37.1 billion at June 30, 2006, from $33.2 billion at the end of Q2/05.
Earnings in the group businesses were $76 million compared with $71 million in the same quarter last year, driven by the positive impact of asset changes, which were somewhat offset by less favourable claims experience. Sales in group businesses can be lumpy and declined to $236 million in the quarter versus $338 million in Q2/05. Group Savings and Retirement Solutions recently announced a new large case sale to Rogers Communications and are expected to close in Q3/06. Premiums and deposits rose to $1.83 billion in Q2/06 from $1.77 billion in Q2/05.
Earnings in the Canadian operations continue to be well balanced between individual life, wealth management and group, and we would expect this balance to remain. We are projecting roughly 24% growth in 2006 and 10% growth in 2007.
Asian Operations
Earnings from Asia (excluding Japan) increased 26% to US$86 million in Q2/06 from US$68 million in Q2/05, primarily due to stronger earnings from the Hong Kong wealth operations. Earnings in Hong Kong increased to US$72 million from US$55 million in Q2/05 due to growth in its in-force insurance business and strong wealth management earnings resulting from higher fee income. Wealth management sales in Hong Kong increased in the quarter to US$318 million from US$116 million in Q2/05, largely due to higher sales in individual wealth management due to the introduction of new funds, good fund performance and improved local equity markets (Table 4). Insurance sales in Hong Kong for the quarter totalled US$28 million, down from US$30 million in Q2/05 and up from US$27 million in the previous quarter, reflecting a shift in sales towards wealth management products.
The core business remains its agency force, where the number of agents in Hong Kong rose slightly to 3,287 from 3,215 in the last quarter. Hong Kong remains the hub of MFC’s operations in Asia and we expect fairly modest earnings growth of 6% in 2006.
Earnings from all Asia territories increased slightly to US$14 million from US$13 million in Q2/05. While relatively small, these other Asian operations represent significant future profits. The number of agents in the other Asian territories increased in the quarter to 16,819 from 16,290 in the prior quarter, which is encouraging. We continue to believe the sales force is the key to long-term growth in Asia.
In the quarter, Manulife announced an agreement to acquire The Pramerica Life Insurance Company in the Philippines from Pramerica Financial. This is the fifth acquisition for Manulife in the Philippines, and we believe that the company will continue to build its position in this region.
Japan
Earnings from Japan were US$92 million in the quarter versus US$39 million a year earlier. The results include US$29 million in gains resulting from the lengthening of the asset portfolio duration on the Daihyaku block, which were partially offset by increased reserves, for a net benefit of C$16 million. Excluding this gain, results in Japan were strong, reflecting good mortality and expense and investment gains.
Sales in variable annuities totalled US$745 million, up 10% from Q2/05, reflecting the successful alliance with BOTM/UFJ. Manulife recently suspended sales of one of its VA products in Japan as it awaits clarification from the Japanese tax authorities regarding withdrawal benefits and the withholding taxes associated with those withdrawals. This particular product accounted for 30% of new VA sales in June and 14% of the segment’s segregated funds under management. Clearly this suspension is likely to impact sales momentum in the short term. However, the company plans on launching a new product in September, so the impact is likely to be modest. We expect VA sales in Japan to weaken in Q3/06 and then resume its growth path.
The agent network dropped to 3,684 from 4,075 in Q2/05, as the company continues to experience some challenges recruiting new agents and is proceeding with its initiatives to enhance agent productivity. Sales of individual insurance totalled US$23 million and are not comparable to prior periods due to a change in reporting methodology, where results from prior periods were not restated. Overall, results from Japan are very encouraging. With a distribution arrangement with BOTM/UFJ, MFC has emerged as one of the largest VA sellers in Japan. We continue to expect results in Japan to benefit from an improving macroeconomic environment and new distribution initiatives by the company.
Reinsurance & Corporate
Reinsurance reported a gain of US$43 million in Q2/06 up from earnings of US$24 million in Q2/05 largely due improved life reinsurance experience gains and improved underwriting margins in the P&C business, slightly offset by poor claims experience.
The corporate segment reported a gain of $18 million, down from $80 million in Q2/05 and $51 million last quarter. The decline is due to lower investment income, basis change charges related to the new reserves in Japan ($19 million pre-tax), the negative impact of corporate tax changes of $15 million on an existing deferred tax asset, partially offset by two arbitrated items that resulted in a net gain of $4 million.
Asset Quality, Capital & Buyback
Gross impaired loans declined by $180 million to $611 million from Q1/06 and similarly net impaired loans decreased by $127 million to $398 million from Q1/06. The decline was largely due the reduction of certain JHF products, like institutional spread-based products, which require more yield to meet targeted returns. We continue to believe the company’s asset quality and coverage are more than adequate. Provisions for future credit defaults in actuarial liabilities declined to $2.7 billion in Q2/06 from $2.9 billion in Q1/06. The decrease reflects the impact from currency and a reduction in below investment grade bonds, which have fallen from $6.9 billion in Q2/05 to $4.7 billion at the end of Q2/06.
Manulife’s main operating subsidiary, Manufacturers Life Insurance Company, had an MCCSR of 211% in Q2/06 versus 224% at the end of Q1/06. The John Hancock Life Insurance Company’s Risk Based Capital Ratio (RBC) remained stable at 359% over the same period. Manulife remains very well capitalized with over $3 billion in excess capital. The CTE level fell to 68 from 73 in Q2/05 and 76 in Q1/06.
The company repurchased roughly 25.7 million shares in the second quarter, which is significantly higher than our projections of 5 million shares per quarter.
Valuation & Recommendation
Overall, results in the quarter were quite good, with earnings growth well diversified across the company and solid sales growth across all segments. Pre-tax profits rose 12% and a lower tax rate helped drive earnings growth to 14% in the quarter. The company continues to benefit from steady earnings contribution from Canada, strong U.S. operations with cost synergies from the JHF acquisition, as well as a growing Asian platform. The company bought back 25.7 million shares in the quarter and with excess capital over $3 billion, ROE of 16.3%, and earnings growth of 15%+ in the medium to long-term, Manulife remains Outperform rated.
Our investment thesis and Outperform rating remain unchanged on Manulife. The acquisition of John Hancock continues to deliver cost and revenue synergies. As well, the acquisition solidified the company’s position as a top three operator in Canada and among the top competitors in the U.S. insurance market. Manulife’s Asian operations, including Japan, offer long term organic growth opportunities that are second only to AIG among global insurers. With excess capital and a history of successful acquisitions, we believe that shareholders will be well rewarded in any future acquisition opportunities. Moreover, we expect dividend increases of 15%+ over the next 12-24 months.
Given results in the quarter, we have adjusted our 2007E EPS slightly to $2.75 from $2.78 and our 2006E EPS remains unchanged at $2.43. Our $40 target price remains unchanged, reflecting 14.5x 2007E EPS and 2.4x 2006E BVPS.
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BMO Capital Markets, 4 August 2006
Quarterly Review
Manulife Financial reported Q2/06 earnings of $960 million, or $0.60 per share versus $839 million, or $0.52 per share in the year-ago period. There were a number of items that affected Q2/06 earnings, but overall we view these second quarter results as in line with consensus and BMO Capital Markets’ estimate of $0.60 for the quarter. In the U.S., strong Wealth Management results offset a somewhat difficult quarter in the Insurance division, while most other operating divisions demonstrated fairly strong operating performance. Second-quarter highlights include:
• Premiums and deposits of $15.9 billion declined from a record $17.9 billion in Q1/06 but were up 10% versus $14.4 billion in Q2/05. On a constant currency basis, premiums and deposits rose 20% year over year. Mutual fund deposits are up an impressive 45%, with annuity and pension premiums also experiencing strong gains. U.S. variable annuity net sales were up 53% versus last year at US$1.4 billion in Q2/06.
• U.S. Insurance and Wealth Management had Q2/06 earnings of $428 million versus $406 million in the year ago quarter. Earnings in U.S. Insurance were somewhat disappointing as poor equity market performance and less robust mortality experience more than offset improving earnings in John Hancock Long Term Care. U.S. Wealth Management reported strong Q2/06 earnings due in part to a $25 million after-tax recovery in the John Hancock Institutional Fixed business and due to lower CTE levels related to segregated fund and variable annuity products. Going forward, we expect that insurance earnings will recover from rather low levels in the current quarter.
• The Canadian division had Q2/06 earnings of $267 million, up from $191 million in the year ago quarter. Earnings came in well ahead of expectations due entirely to a $42 million gain related to favourable changes to corporate tax rates in Canada. Also of note, Individual Life Insurance had better than expected lapse experience and Individual Wealth Management benefited from solid business growth against a backdrop of double-digit growth in funds under management.
• The Japan division had net earnings of US$92 million compared with US$39 million in the year ago period. Second quarter earnings benefited from reserve releases relating to the repositioning of Daihyaku’s balance sheet in addition to strong variable annuity sales. It is expected that variable annuity sales will decline in the second half of 2006 as a product that accounts for approximately 30% of sales has been removed from the marketplace due to potential taxation issues. Hong Kong earnings were also strong in the quarter at US$72 million, up from US$55 million in Q2/05.
Capital
Manulife continues to maintain a very conservative balance sheet; however, the repurchase of 25.7 million common shares at a total cost of $933 million in addition to currency translation adjustments led to a decline in common equity of approximately $900 million. As a result, debt and preferreds to total capital increased in Q2/06 to 17.9% versus 17.5% in Q1/06, however Manulife continues to maintain very conservative leverage ratios. MCCSR declined somewhat versus the first quarter to 211% from 224%, however Tier 1 capital as % of Required Capital improved marginally to 181% from 179% in Q1/06.
Asset quality experience was exceptional at Manulife this quarter. Gross and net impaired assets declined from the first quarter and net impaired assets remain extremely low at 24 bps of invested assets (Table 2). Manulife also continues to improve the quality of its bond portfolio. Non-investment grade bonds declined $500 million from Q1/06 due to repayments and asset sales, and bonds rated A or better now account for 70% of the total portfolio.
Credit Rating
Standard and Poor’s revised its outlook on Manulife to Positive from Stable at the end of 2005, and since then Manulife has continued to generate strong operating results while maintaining very reasonable balance sheet leverage. An upgrade by Standard and Poor’s would result in a AAA financial strength rating for Manufacturers Life Insurance Co., and while we do not believe management is pursuing the upgrade, in our view the rating agency could move ahead with an upgrade at any time.
Recommendation
Asset quality experience was exceptional in the quarter and capital metrics remain quite conservative at Manulife. Overall we view this as another strong quarter from a credit perspective, and Manulife continues to be our favourite credit among large capitalization financials.
Quarterly Review
Manulife Financial reported Q2/06 earnings of $960 million, or $0.60 per share versus $839 million, or $0.52 per share in the year-ago period. There were a number of items that affected Q2/06 earnings, but overall we view these second quarter results as in line with consensus and BMO Capital Markets’ estimate of $0.60 for the quarter. In the U.S., strong Wealth Management results offset a somewhat difficult quarter in the Insurance division, while most other operating divisions demonstrated fairly strong operating performance. Second-quarter highlights include:
• Premiums and deposits of $15.9 billion declined from a record $17.9 billion in Q1/06 but were up 10% versus $14.4 billion in Q2/05. On a constant currency basis, premiums and deposits rose 20% year over year. Mutual fund deposits are up an impressive 45%, with annuity and pension premiums also experiencing strong gains. U.S. variable annuity net sales were up 53% versus last year at US$1.4 billion in Q2/06.
• U.S. Insurance and Wealth Management had Q2/06 earnings of $428 million versus $406 million in the year ago quarter. Earnings in U.S. Insurance were somewhat disappointing as poor equity market performance and less robust mortality experience more than offset improving earnings in John Hancock Long Term Care. U.S. Wealth Management reported strong Q2/06 earnings due in part to a $25 million after-tax recovery in the John Hancock Institutional Fixed business and due to lower CTE levels related to segregated fund and variable annuity products. Going forward, we expect that insurance earnings will recover from rather low levels in the current quarter.
• The Canadian division had Q2/06 earnings of $267 million, up from $191 million in the year ago quarter. Earnings came in well ahead of expectations due entirely to a $42 million gain related to favourable changes to corporate tax rates in Canada. Also of note, Individual Life Insurance had better than expected lapse experience and Individual Wealth Management benefited from solid business growth against a backdrop of double-digit growth in funds under management.
• The Japan division had net earnings of US$92 million compared with US$39 million in the year ago period. Second quarter earnings benefited from reserve releases relating to the repositioning of Daihyaku’s balance sheet in addition to strong variable annuity sales. It is expected that variable annuity sales will decline in the second half of 2006 as a product that accounts for approximately 30% of sales has been removed from the marketplace due to potential taxation issues. Hong Kong earnings were also strong in the quarter at US$72 million, up from US$55 million in Q2/05.
Capital
Manulife continues to maintain a very conservative balance sheet; however, the repurchase of 25.7 million common shares at a total cost of $933 million in addition to currency translation adjustments led to a decline in common equity of approximately $900 million. As a result, debt and preferreds to total capital increased in Q2/06 to 17.9% versus 17.5% in Q1/06, however Manulife continues to maintain very conservative leverage ratios. MCCSR declined somewhat versus the first quarter to 211% from 224%, however Tier 1 capital as % of Required Capital improved marginally to 181% from 179% in Q1/06.
Asset quality experience was exceptional at Manulife this quarter. Gross and net impaired assets declined from the first quarter and net impaired assets remain extremely low at 24 bps of invested assets (Table 2). Manulife also continues to improve the quality of its bond portfolio. Non-investment grade bonds declined $500 million from Q1/06 due to repayments and asset sales, and bonds rated A or better now account for 70% of the total portfolio.
Credit Rating
Standard and Poor’s revised its outlook on Manulife to Positive from Stable at the end of 2005, and since then Manulife has continued to generate strong operating results while maintaining very reasonable balance sheet leverage. An upgrade by Standard and Poor’s would result in a AAA financial strength rating for Manufacturers Life Insurance Co., and while we do not believe management is pursuing the upgrade, in our view the rating agency could move ahead with an upgrade at any time.
Recommendation
Asset quality experience was exceptional in the quarter and capital metrics remain quite conservative at Manulife. Overall we view this as another strong quarter from a credit perspective, and Manulife continues to be our favourite credit among large capitalization financials.
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Scotia Capital, 4 August 2006
Noisy Q2/06 - Downgrade primarily on valuation
• In-line or was it? Manulife reported $0.60 per share, in-line with our estimate and consensus, for 11% EPS growth. The quarter had a lot of noise, more than we'd like to see, and if anything the run-rate number, excluding one-timers was $0.03 lower, in our opinion. We believe Manulife is now more sensitive to equity markets (more likely the S&P500 as opposed to the TSX) than we had originally anticipated in part due to unexpected volatility in the company's U.S. universal life and variable universal life block. We believe a 3% QOQ decline in equity markets could negatively impact EPS by up $0.06-$0.09 per share.
• Downgrading primarily on valuation and expected decline in momentum in U.S. topline growth. We are downgrading Manulife's shares from a 1-Sector Outperform to 2-Sector Perform, primarily on valuation. Trading at 13x our 2007E EPS estimate we believe the stock is fairly valued relative to its expected 13% EPS growth in 2007. As well, the stock trades an 8% premium to its North American peer group on the P/BV versus ROE basis. With 10% upside versus our share price target, we see a little better value and return in other Canadian lifecos. In addition, we expect Manulife's multiple relative to the other Canadian lifecos will no longer expand, as the company is now expected to move from a position of gaining market share to a position of maintaining market share.
• A little more noise that we'd like to see - we put net impact at a positive $0.03-$0.04 per share. A company of this size and with all these segments will naturally have a lot of moving parts, and we don't believe investors should get too caught up in micro-analyzing quarterly movements that may appear to be one-timers in each segment. Nevertheless, we categorize "unusuals", all after tax, as a $27 million gain from tax changes, a $25 million gain from recoveries of pre-merger assets, a $4 million gain from arbitrated items, a $22 million gain from asset mix changes on reserves in Canada, a $29 million gain related to the extension of the portfolio duration in Japan and reduced Daihyaku exposure to equities, and a $12 million loss due to a reserve adjustment related to book value surrenders in Japan. All this nets to positive $95 million or about $0.06 per share. The company did note that unfavourable equity markets negatively impacted results by $40 million (or $0.025 per share), although we note that had the company increased reserves for segregated fund//variable annuity guarantees as opposed to letting the CTE (conditional tail expectation) level fall from 76% to 68% QoQ, the negative impact would have been significantly higher. The company also noted results in reinsurance, a historically volatile segment, were weak, we estimate by $0.01-$0.02.
• Modest EPS adjustments to reflect weaker equity markets. We look for 13% EPS growth in 2007. We reduced our EPS estimates by $0.01 per share in 2006 and $0.03 per share in 2007.
• Our estimates do not include any potential one-time reserve release (i.e. gain) due to rising long term interest rates - we anticipate this may be mitigated to some extent by increased reserves for weaker equity markets. On the call management noted that rising long term interest rates (Canada 10-years are up 35bps from 2005 year end, and U.S. 10- years are up 57 bps) could lead to a one-time positive impact, through a reserve release, with respect to the company's protection products. As part of its 2005 year-end reserve review, where the company moved reserves for all sorts of assumption changes, amounting to a $0.04 per share one-time increase in EPS (post split), the amount of strengthening for interest rate risk was approximately $0.15 per share (after-tax, post split). Even if the company released 2/3rds of this amount as part of its 2006 year end reserve review, the one-time gain in Q4/06 would be $0.10 per share. We estimate this would be offset, to some extent, by additional reserves for equity market risk, as the company would revisit its CTE level. Had the company kept reserves at CTE 76% we estimate the one-time hit to EPS would be $0.05 per share in Q2/06.
• U.S. Division up 9% (ex f/x), as reserve strengthening in individual insurance owing to weak equity markets takes a bite out of what would have been a quarter with earnings up 15% - this segment is more sensitive to equity market risk than we anticipated. The S&P500 is flat since June 30, 2006. Should it decline in Q3/06 as it did in Q2/06 we would expect the company to take another US$30 million (i.e. $0.02 per share) reserve hit in its individual insurance segment. We would expect further hits related to the company's variable annuity products. While we appreciate the long duration of the universal life product, and potential hit to earnings through a reserve increase, if projected fees, essentially MERs, are lower than anticipated, we did not expect the hit to be so high. As well, by letting the CTE (Conditional tail expectation) level on the variable annuity reserves fall from 76% to 68% QOQ and thus avoid a significant reserve increase for variable annuity guarantees, we come to the conclusion that the U.S. business is much more sensitive to equity market risk than we had originally anticipated. This additional volatility, in our opinion, is a negative.
• Excellent top-line growth in U.S. - but going forward we expect company to "maintain" rather than "gain" market share. Positives include, as expected, strong sales growth across all segments (variable annuity sales up 41%, individual life insurance sales up 34%, long-term care sales up 44%, 401(k) sales up 13%, and mutual fund sales up 69%). However, as emphasized by management at the company's June 13, 2006 Investor Day, the level of sales growth, particularly for variable annuity, is expected to slow in Q3 and Q4, as the company reaches a year's worth of VA sales for its highly successful Principal Plus for Life rider, (and thus YOY growth comparables will return to more "normal" levels). Also, competitors are now copying the product. In individual insurance we expect the pace of sales to return to more normal industry levels (single digits, to possibly low digits) as the company is now #1 overall in sales for the last twelve months. When you are the largest in the industry it is increasingly more difficult to grow exceptionally faster than the industry, in our opinion. Also, we believe the competitiveness of the company's universal life product may suffer to some extent as management indicated it will be re-pricing its guaranteed universal life at the older ages, with prices likely increasing.
• Earnings for Canadian division up 6% excluding one-time tax gain and one-time positive impact of asset mix changes on reserves. A weaker-than-expected quarter in Canada, with unfavourable markets and unfavourable claims experience offset to some extent by favourable lapse experience. While segregated fund and mutual fund net flows remained positive, they were down significantly from previous levels, and are at their lowest levels in the last 10 quarters. The company looks to improve segregated fund net flows and individual wealth management premiums and deposits (which were down 7% YOY) with a new segregated fund product, expected to be launched in Q4/06. Citing an irrational universal life market in Canada, Manulife continues to keep sales flat, reflecting its pricing discipline. Group revenue premiums were flat YOY (with earnings up 7%), but this segment is expected to benefit from a group retirement case sale to Rogers Communications, expected to close Q3/06. Excluding the one-time tax gains and the one-time positive impact of asset mix changes on reserves, the Individual wealth management was the only the only segment particularly strong, with earnings up 23% YOY despite the significantly lower level of net sales, in part owing to the company's decision to not maintain its CTE (Conditional Tail Expectation) level on segregated fund reserves at Q1/06 levels of 76%, allowing it to fall, to 68% at Q2/06. Standards require this level to be between 60% and 80%, We suspect that had the company maintained the CTE level at 76%, a portion (at least half, we estimate), of the YOY earnings gain in the individual wealth management segment would have been negated. We expect the company to "revisit" its CTE approach more formally at 2006 year end.
• Hong Kong strong - contributes to all of Asia's 26% earnings growth (ex f/x) in Q2/06 and 19% YTD - "Other Asia" weak. Hong Kong led the Asian operations (ex-Japan), with 31% YOY increase in earnings in Q2/06 on a USD basis (operations are pegged to the USD), led largely by excellent growth in wealth management sales and the associated improved fee income. Wealth management sales in this division continue to grow (sales up 81% in Q2/06, after increasing 107% in Q1/06) as the company benefited from recently launched new mutual funds and buoyant equity markets. "Other Asia", or the business outside of Hong Kong (but not Japan) had earnings growth of just 8% YOY (in USD), and only 3% growth YTD, owing to weak equity markets.
• One-timers help Japan - but now that these are virtually complete we look for more reasonable 12% growth (ex f/x) for 2007 - could be lower due to VA product suspension. Japan earnings growth in Q2/06 was particularly robust (more than doubling, ex f/x, over a relatively weak Q2/05) as the company continues to book one-time gains associated with repositioning its asset portfolio. Excluding the gain, we put earnings growth for the segment at a very strong 60%, and nearly 30% higher QOQ (excluding the asset repositioning in Q1/06), as the company benefited from very good mortality experience, expense gains and growth in the variable annuity block. The asset repositioning, and its associated one-time gains, are all but complete as of Q2/06. Given this, and assuming a return to more normalized claims experience levels, plus a more than likely a decline in variable annuity sales as the company, in mid-July 2006, for client tax reasons, voluntarily suspended a VA product that accounted for 30% of its VA sales (and likely won't launch a replacement until late September), we expect earnings in Japan to be in the 12% range (ex f/x) in 2007 over a rather strong 2006 that had the benefit of one-time gains. While we believe the Japanese variable annuity market is a growth market, we note that competitors such as Hartford Life, whose variable annuity sales in Japan were down 48%, are seeing significantly increased competition in this market, particularly from domestic players. Clearly the momentum in Manulife's variable annuity sales growth is declining, with sales up 10% in Q2/06, after increasing 24% in Q1/06, 72% in Q4/05 and 69% in 2005. In addition, individual insurance sales continue to decline, down 22% in quarter and 20% YTD, as the number of agents, continues to decline, down 10% YOY and 1% QOQ.
• Asset quality continues to improve. Below investment grade bonds fell 10% QOQ to $4.7 million, due to sales and prepayments. Below investment grade bonds now represent 4.6% of the company's bond portfolio, down from 6.5% on Q2/05.
• ROE at 16.3% up 200 bps YOY (flat QOQ) - with ROE back at company target and John Hancock acquisition complete is it time for another acquisition? We expect company to remain patient, and buyback more stock. It clearly has not taken long since the closing of the John Hancock acquisition (closed in April, 2004) for the company to get its ROE back up to its initially targeted 16% level. We expect the ROE to modestly surpass the 16% target in 2007. We expect the company to increase its buyback activity, and gradually increase its payout ratio from its current 29% of 2006E to a level toward the top-end of its targeted 25%-35% range.
Noisy Q2/06 - Downgrade primarily on valuation
• In-line or was it? Manulife reported $0.60 per share, in-line with our estimate and consensus, for 11% EPS growth. The quarter had a lot of noise, more than we'd like to see, and if anything the run-rate number, excluding one-timers was $0.03 lower, in our opinion. We believe Manulife is now more sensitive to equity markets (more likely the S&P500 as opposed to the TSX) than we had originally anticipated in part due to unexpected volatility in the company's U.S. universal life and variable universal life block. We believe a 3% QOQ decline in equity markets could negatively impact EPS by up $0.06-$0.09 per share.
• Downgrading primarily on valuation and expected decline in momentum in U.S. topline growth. We are downgrading Manulife's shares from a 1-Sector Outperform to 2-Sector Perform, primarily on valuation. Trading at 13x our 2007E EPS estimate we believe the stock is fairly valued relative to its expected 13% EPS growth in 2007. As well, the stock trades an 8% premium to its North American peer group on the P/BV versus ROE basis. With 10% upside versus our share price target, we see a little better value and return in other Canadian lifecos. In addition, we expect Manulife's multiple relative to the other Canadian lifecos will no longer expand, as the company is now expected to move from a position of gaining market share to a position of maintaining market share.
• A little more noise that we'd like to see - we put net impact at a positive $0.03-$0.04 per share. A company of this size and with all these segments will naturally have a lot of moving parts, and we don't believe investors should get too caught up in micro-analyzing quarterly movements that may appear to be one-timers in each segment. Nevertheless, we categorize "unusuals", all after tax, as a $27 million gain from tax changes, a $25 million gain from recoveries of pre-merger assets, a $4 million gain from arbitrated items, a $22 million gain from asset mix changes on reserves in Canada, a $29 million gain related to the extension of the portfolio duration in Japan and reduced Daihyaku exposure to equities, and a $12 million loss due to a reserve adjustment related to book value surrenders in Japan. All this nets to positive $95 million or about $0.06 per share. The company did note that unfavourable equity markets negatively impacted results by $40 million (or $0.025 per share), although we note that had the company increased reserves for segregated fund//variable annuity guarantees as opposed to letting the CTE (conditional tail expectation) level fall from 76% to 68% QoQ, the negative impact would have been significantly higher. The company also noted results in reinsurance, a historically volatile segment, were weak, we estimate by $0.01-$0.02.
• Modest EPS adjustments to reflect weaker equity markets. We look for 13% EPS growth in 2007. We reduced our EPS estimates by $0.01 per share in 2006 and $0.03 per share in 2007.
• Our estimates do not include any potential one-time reserve release (i.e. gain) due to rising long term interest rates - we anticipate this may be mitigated to some extent by increased reserves for weaker equity markets. On the call management noted that rising long term interest rates (Canada 10-years are up 35bps from 2005 year end, and U.S. 10- years are up 57 bps) could lead to a one-time positive impact, through a reserve release, with respect to the company's protection products. As part of its 2005 year-end reserve review, where the company moved reserves for all sorts of assumption changes, amounting to a $0.04 per share one-time increase in EPS (post split), the amount of strengthening for interest rate risk was approximately $0.15 per share (after-tax, post split). Even if the company released 2/3rds of this amount as part of its 2006 year end reserve review, the one-time gain in Q4/06 would be $0.10 per share. We estimate this would be offset, to some extent, by additional reserves for equity market risk, as the company would revisit its CTE level. Had the company kept reserves at CTE 76% we estimate the one-time hit to EPS would be $0.05 per share in Q2/06.
• U.S. Division up 9% (ex f/x), as reserve strengthening in individual insurance owing to weak equity markets takes a bite out of what would have been a quarter with earnings up 15% - this segment is more sensitive to equity market risk than we anticipated. The S&P500 is flat since June 30, 2006. Should it decline in Q3/06 as it did in Q2/06 we would expect the company to take another US$30 million (i.e. $0.02 per share) reserve hit in its individual insurance segment. We would expect further hits related to the company's variable annuity products. While we appreciate the long duration of the universal life product, and potential hit to earnings through a reserve increase, if projected fees, essentially MERs, are lower than anticipated, we did not expect the hit to be so high. As well, by letting the CTE (Conditional tail expectation) level on the variable annuity reserves fall from 76% to 68% QOQ and thus avoid a significant reserve increase for variable annuity guarantees, we come to the conclusion that the U.S. business is much more sensitive to equity market risk than we had originally anticipated. This additional volatility, in our opinion, is a negative.
• Excellent top-line growth in U.S. - but going forward we expect company to "maintain" rather than "gain" market share. Positives include, as expected, strong sales growth across all segments (variable annuity sales up 41%, individual life insurance sales up 34%, long-term care sales up 44%, 401(k) sales up 13%, and mutual fund sales up 69%). However, as emphasized by management at the company's June 13, 2006 Investor Day, the level of sales growth, particularly for variable annuity, is expected to slow in Q3 and Q4, as the company reaches a year's worth of VA sales for its highly successful Principal Plus for Life rider, (and thus YOY growth comparables will return to more "normal" levels). Also, competitors are now copying the product. In individual insurance we expect the pace of sales to return to more normal industry levels (single digits, to possibly low digits) as the company is now #1 overall in sales for the last twelve months. When you are the largest in the industry it is increasingly more difficult to grow exceptionally faster than the industry, in our opinion. Also, we believe the competitiveness of the company's universal life product may suffer to some extent as management indicated it will be re-pricing its guaranteed universal life at the older ages, with prices likely increasing.
• Earnings for Canadian division up 6% excluding one-time tax gain and one-time positive impact of asset mix changes on reserves. A weaker-than-expected quarter in Canada, with unfavourable markets and unfavourable claims experience offset to some extent by favourable lapse experience. While segregated fund and mutual fund net flows remained positive, they were down significantly from previous levels, and are at their lowest levels in the last 10 quarters. The company looks to improve segregated fund net flows and individual wealth management premiums and deposits (which were down 7% YOY) with a new segregated fund product, expected to be launched in Q4/06. Citing an irrational universal life market in Canada, Manulife continues to keep sales flat, reflecting its pricing discipline. Group revenue premiums were flat YOY (with earnings up 7%), but this segment is expected to benefit from a group retirement case sale to Rogers Communications, expected to close Q3/06. Excluding the one-time tax gains and the one-time positive impact of asset mix changes on reserves, the Individual wealth management was the only the only segment particularly strong, with earnings up 23% YOY despite the significantly lower level of net sales, in part owing to the company's decision to not maintain its CTE (Conditional Tail Expectation) level on segregated fund reserves at Q1/06 levels of 76%, allowing it to fall, to 68% at Q2/06. Standards require this level to be between 60% and 80%, We suspect that had the company maintained the CTE level at 76%, a portion (at least half, we estimate), of the YOY earnings gain in the individual wealth management segment would have been negated. We expect the company to "revisit" its CTE approach more formally at 2006 year end.
• Hong Kong strong - contributes to all of Asia's 26% earnings growth (ex f/x) in Q2/06 and 19% YTD - "Other Asia" weak. Hong Kong led the Asian operations (ex-Japan), with 31% YOY increase in earnings in Q2/06 on a USD basis (operations are pegged to the USD), led largely by excellent growth in wealth management sales and the associated improved fee income. Wealth management sales in this division continue to grow (sales up 81% in Q2/06, after increasing 107% in Q1/06) as the company benefited from recently launched new mutual funds and buoyant equity markets. "Other Asia", or the business outside of Hong Kong (but not Japan) had earnings growth of just 8% YOY (in USD), and only 3% growth YTD, owing to weak equity markets.
• One-timers help Japan - but now that these are virtually complete we look for more reasonable 12% growth (ex f/x) for 2007 - could be lower due to VA product suspension. Japan earnings growth in Q2/06 was particularly robust (more than doubling, ex f/x, over a relatively weak Q2/05) as the company continues to book one-time gains associated with repositioning its asset portfolio. Excluding the gain, we put earnings growth for the segment at a very strong 60%, and nearly 30% higher QOQ (excluding the asset repositioning in Q1/06), as the company benefited from very good mortality experience, expense gains and growth in the variable annuity block. The asset repositioning, and its associated one-time gains, are all but complete as of Q2/06. Given this, and assuming a return to more normalized claims experience levels, plus a more than likely a decline in variable annuity sales as the company, in mid-July 2006, for client tax reasons, voluntarily suspended a VA product that accounted for 30% of its VA sales (and likely won't launch a replacement until late September), we expect earnings in Japan to be in the 12% range (ex f/x) in 2007 over a rather strong 2006 that had the benefit of one-time gains. While we believe the Japanese variable annuity market is a growth market, we note that competitors such as Hartford Life, whose variable annuity sales in Japan were down 48%, are seeing significantly increased competition in this market, particularly from domestic players. Clearly the momentum in Manulife's variable annuity sales growth is declining, with sales up 10% in Q2/06, after increasing 24% in Q1/06, 72% in Q4/05 and 69% in 2005. In addition, individual insurance sales continue to decline, down 22% in quarter and 20% YTD, as the number of agents, continues to decline, down 10% YOY and 1% QOQ.
• Asset quality continues to improve. Below investment grade bonds fell 10% QOQ to $4.7 million, due to sales and prepayments. Below investment grade bonds now represent 4.6% of the company's bond portfolio, down from 6.5% on Q2/05.
• ROE at 16.3% up 200 bps YOY (flat QOQ) - with ROE back at company target and John Hancock acquisition complete is it time for another acquisition? We expect company to remain patient, and buyback more stock. It clearly has not taken long since the closing of the John Hancock acquisition (closed in April, 2004) for the company to get its ROE back up to its initially targeted 16% level. We expect the ROE to modestly surpass the 16% target in 2007. We expect the company to increase its buyback activity, and gradually increase its payout ratio from its current 29% of 2006E to a level toward the top-end of its targeted 25%-35% range.
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RBC Capital Markets, 4 August 2006
2¢ EPS Shortfall Looks Easily Recoverable.
Manulife delivered 60¢ EPS in line with consensus. However, the 60¢ included a 2¢ one-time tax benefit, indicating underlying EPS at 58¢, ~2¢ below expectations. Relative to our estimate, the 2¢ EPS shortfall seems to reflect the adverse impact of difficult equity markets on fee revenue, as well as some adverse claims experience, both we expect to be aberrational and likely to normalize. On the other hand, it does seem we underestimated the adverse equity leverage issue for all the lifeco’s this
quarter, some more so than others.
We believe Manulife specifically has the capacity to recapture its 2¢ shortfall, and then some, in Q3 as a result of (i) the very strong organic sales momentum (~1-2¢/quarter); (ii) the falling share count (1¢/quarter); (iii) stable equity markets (+2¢ addback next quarter), and (iv) rising average bond yields (1¢). Our Q306 EPS estimate remains 63¢, up ~5¢ QoQ from the Q2 underlying, and for Q406 we are still carrying 67¢.
We are also assuming the CAD/USD remains roughly level in the current 1.12 range, which would alleviate YoY foreign exchange translation drag by ~2% in Q306, and another 3% in Q406.
Further, in Q406, Manulife may also release some investment reserves as a result of the higher interest rate environment - this may have a material non-sustainable EPS impact, and is not included in our EPS estimates.
Excellent Underlying Growth at ~22% YoY
In Q206, Manulife converted 14% earnings growth YoY to 17% EPS growth YoY by managing down its share count. The EPS growth was on the order of 22% in constant currency and excluded the net one-time benefit of the recently lowered Canadian tax. We think this strong constant currency growth reflects a combination of the very impressive and diverse sales and revenue results, coupled with better reserve and experience results.
Sales momentum remained excellent. In the U.S, life sales jumped 34% YoY, variable annuity sales by 41% YoY, and mutual fund sales by 69%. In Asia, Hong Kong fund sales jumped by 228%, and Japanese VA sales grew 10% from its high base.
Manulife bought back an unusually high 25.7 million share in the quarter, spending upwards of $1 billion in cash. Still the company estimates excess capital remains in the $3 billion range, roughly where it was a year ago. Such is the dilemma of strong internal cash generation.
Investment Reserve Release?
The company let its segregated fund reserve for equity exposure decline, seemingly at odds with the market move and with peer actions. The standard measure of margin fell to CTE-68, down from CTE-76 (and well below Sun Life's at CTE-80). It seemed quite strange to be releasing what amounted to $105M in equity reserves in the same period that the equity market weakness took an estimated $40 million off the U.S. VUL earnings contribution and other fee-sensitive revenue streams. For this we have no cogent explanation, and it does bring the quality of earnings into some question. This, however, is not the first time we have seen this sort of oddball quarter and it may not be the last.
U.S. Division Earnings (45% of Total) Decline on Weak Equity Markets
This division has been driving a 35% average YoY growth rate during the past 6 quarters, assisted greatly by the John Hancock integration.
U.S. individual insurance net income dipped 19% YoY to CAD$127 million. This is the lowest level since the Hancock deal close in Q204, to contribute only 13% of Manulife’s overall earnings. In USD, the decline was less severe at 11% and USD$14 million. A significant factor was the U.S. life divisional share of the company-wide $40 million impact cited for lower equity markets, specifically driving lower fee revenue in this division’s variable universal life portfolio. Management also cited less favourable claims experience YoY. Reviewing the sources of earnings statement was encouraging and corroborated the explanations: (i) experience gains dipped $USD46 million YoY (equity markets and claims costs) and (ii) other swung - $USD12 million. On the other hand, profit from in-force rose 12% YoY and sales strain this quarter was negligible, down from a $23 million cost a year, back in the early days of Manulife’s extensive product overall. These factors lend credence to the underlying sustainability of divisional profit, with significant upside potential if experience and ‘Other’ normalize.
All this noise was ironic considering U.S. life sales were a record Q2 level, up 35% YoY, and the second highest on record for any quarter. And to see MFC’s U.S. universal life sales remain so strong is very impressive juxtaposed to some predatory pricing in the U.S. market this quarter. Sun Life, for example, intentionally left its products “off-priced” to satisfy new distribution agreements. Sun Life’s products will be re-priced and restructured during the balance of the year to accommodate new reinsurance price points and reduce sales strain, a process Manulife took care of 12-18 months ago. Accordingly, we would expect Sun Life’s sales may be more vulnerable than Manulife’s over the course of the next 12 months. We read some other U.S domiciled underwriters also are in Sun Life’s position. A general market pricing correction around Manulife should only strengthen its own relative sales competitiveness going forward.
The smaller component of Manulife’s U.S. insurance business is the long-term care – this business is also growing very strongly, with sales up 44% YoY. We think this is a valuable business, operating still in a slightly less competitive market. Manulife believes it ranks #1, up from #7 in overall sales for the 12 months to Q106.
Without the equity market ‘pain’, we would expect divisional earnings to rebound up to $$40 million next quarter, and beyond
U.S. Wealth Management net income leapt 35% YoY to USD$268 million.
The U.S. wealth earnings looked unsustainably strong as it included a $105 million segregated fund reserve release. It was attributed to a formulaic 4-quarter average methodology uniformly applied each quarter, although its timing seemed very odd given the adverse movement in equity markets (just described as an earnings cost in the individual insurance division).
The variable product group accounted for US$114 million of net income, up 30% YoY. Underlying momentum was underpinned by the 20% YoY gain in funds under management (measured in USD). This drove similarly higher fee income and helped offset the adverse equity market impact.
Sales were exceptional, again. Variable annuity sales leapt 67% YoY to $2.5 billion for a solid #2 rank in the U.S. market among non-proprietary providers. Retirement plan services sales jumped 19% and mutual fund deposits rocketed up 69%.
Earnings from the variable group look sustainable at this higher level.
The fixed products group contributed USD$154 million of net income, and this is where there were non-recurring earnings pick-up from gains on sale of pre-merger John Hancock institutional assets, as well as support from favourable investment experience. Management coordinated the sale of about USD$1 billion in institutional assets, not out of line with prior quarters, but apparently with more profit impact. Earnings from this group will probably retrench about $30-40 million in future quarters.
Canada - Earnings Exceptionally Strong (28% of Total Net Income)
Excluding one-time tax items, earnings grew 26% YoY to $267 million. This included the $42 million one-time tax benefit, indicating underlying growth at 18% YoY. This division has been driving a 33% average YoY growth rate during the past 6 quarters, assisted greatly by the Maritime Life acquisition. Aside from the tax benefit in the quarter, higher experience gains, including favourable lapse, and earnings on surplus were the biggest earnings drivers. A change in asset mix had a $22 million reserve benefit. The negative impact of equity markets and ~$13 million less favourable claims experience in the Group business kept a lid on earnings growth this quarter.
2¢ EPS Shortfall Looks Easily Recoverable.
Manulife delivered 60¢ EPS in line with consensus. However, the 60¢ included a 2¢ one-time tax benefit, indicating underlying EPS at 58¢, ~2¢ below expectations. Relative to our estimate, the 2¢ EPS shortfall seems to reflect the adverse impact of difficult equity markets on fee revenue, as well as some adverse claims experience, both we expect to be aberrational and likely to normalize. On the other hand, it does seem we underestimated the adverse equity leverage issue for all the lifeco’s this
quarter, some more so than others.
We believe Manulife specifically has the capacity to recapture its 2¢ shortfall, and then some, in Q3 as a result of (i) the very strong organic sales momentum (~1-2¢/quarter); (ii) the falling share count (1¢/quarter); (iii) stable equity markets (+2¢ addback next quarter), and (iv) rising average bond yields (1¢). Our Q306 EPS estimate remains 63¢, up ~5¢ QoQ from the Q2 underlying, and for Q406 we are still carrying 67¢.
We are also assuming the CAD/USD remains roughly level in the current 1.12 range, which would alleviate YoY foreign exchange translation drag by ~2% in Q306, and another 3% in Q406.
Further, in Q406, Manulife may also release some investment reserves as a result of the higher interest rate environment - this may have a material non-sustainable EPS impact, and is not included in our EPS estimates.
Excellent Underlying Growth at ~22% YoY
In Q206, Manulife converted 14% earnings growth YoY to 17% EPS growth YoY by managing down its share count. The EPS growth was on the order of 22% in constant currency and excluded the net one-time benefit of the recently lowered Canadian tax. We think this strong constant currency growth reflects a combination of the very impressive and diverse sales and revenue results, coupled with better reserve and experience results.
Sales momentum remained excellent. In the U.S, life sales jumped 34% YoY, variable annuity sales by 41% YoY, and mutual fund sales by 69%. In Asia, Hong Kong fund sales jumped by 228%, and Japanese VA sales grew 10% from its high base.
Manulife bought back an unusually high 25.7 million share in the quarter, spending upwards of $1 billion in cash. Still the company estimates excess capital remains in the $3 billion range, roughly where it was a year ago. Such is the dilemma of strong internal cash generation.
Investment Reserve Release?
The company let its segregated fund reserve for equity exposure decline, seemingly at odds with the market move and with peer actions. The standard measure of margin fell to CTE-68, down from CTE-76 (and well below Sun Life's at CTE-80). It seemed quite strange to be releasing what amounted to $105M in equity reserves in the same period that the equity market weakness took an estimated $40 million off the U.S. VUL earnings contribution and other fee-sensitive revenue streams. For this we have no cogent explanation, and it does bring the quality of earnings into some question. This, however, is not the first time we have seen this sort of oddball quarter and it may not be the last.
U.S. Division Earnings (45% of Total) Decline on Weak Equity Markets
This division has been driving a 35% average YoY growth rate during the past 6 quarters, assisted greatly by the John Hancock integration.
U.S. individual insurance net income dipped 19% YoY to CAD$127 million. This is the lowest level since the Hancock deal close in Q204, to contribute only 13% of Manulife’s overall earnings. In USD, the decline was less severe at 11% and USD$14 million. A significant factor was the U.S. life divisional share of the company-wide $40 million impact cited for lower equity markets, specifically driving lower fee revenue in this division’s variable universal life portfolio. Management also cited less favourable claims experience YoY. Reviewing the sources of earnings statement was encouraging and corroborated the explanations: (i) experience gains dipped $USD46 million YoY (equity markets and claims costs) and (ii) other swung - $USD12 million. On the other hand, profit from in-force rose 12% YoY and sales strain this quarter was negligible, down from a $23 million cost a year, back in the early days of Manulife’s extensive product overall. These factors lend credence to the underlying sustainability of divisional profit, with significant upside potential if experience and ‘Other’ normalize.
All this noise was ironic considering U.S. life sales were a record Q2 level, up 35% YoY, and the second highest on record for any quarter. And to see MFC’s U.S. universal life sales remain so strong is very impressive juxtaposed to some predatory pricing in the U.S. market this quarter. Sun Life, for example, intentionally left its products “off-priced” to satisfy new distribution agreements. Sun Life’s products will be re-priced and restructured during the balance of the year to accommodate new reinsurance price points and reduce sales strain, a process Manulife took care of 12-18 months ago. Accordingly, we would expect Sun Life’s sales may be more vulnerable than Manulife’s over the course of the next 12 months. We read some other U.S domiciled underwriters also are in Sun Life’s position. A general market pricing correction around Manulife should only strengthen its own relative sales competitiveness going forward.
The smaller component of Manulife’s U.S. insurance business is the long-term care – this business is also growing very strongly, with sales up 44% YoY. We think this is a valuable business, operating still in a slightly less competitive market. Manulife believes it ranks #1, up from #7 in overall sales for the 12 months to Q106.
Without the equity market ‘pain’, we would expect divisional earnings to rebound up to $$40 million next quarter, and beyond
U.S. Wealth Management net income leapt 35% YoY to USD$268 million.
The U.S. wealth earnings looked unsustainably strong as it included a $105 million segregated fund reserve release. It was attributed to a formulaic 4-quarter average methodology uniformly applied each quarter, although its timing seemed very odd given the adverse movement in equity markets (just described as an earnings cost in the individual insurance division).
The variable product group accounted for US$114 million of net income, up 30% YoY. Underlying momentum was underpinned by the 20% YoY gain in funds under management (measured in USD). This drove similarly higher fee income and helped offset the adverse equity market impact.
Sales were exceptional, again. Variable annuity sales leapt 67% YoY to $2.5 billion for a solid #2 rank in the U.S. market among non-proprietary providers. Retirement plan services sales jumped 19% and mutual fund deposits rocketed up 69%.
Earnings from the variable group look sustainable at this higher level.
The fixed products group contributed USD$154 million of net income, and this is where there were non-recurring earnings pick-up from gains on sale of pre-merger John Hancock institutional assets, as well as support from favourable investment experience. Management coordinated the sale of about USD$1 billion in institutional assets, not out of line with prior quarters, but apparently with more profit impact. Earnings from this group will probably retrench about $30-40 million in future quarters.
Canada - Earnings Exceptionally Strong (28% of Total Net Income)
Excluding one-time tax items, earnings grew 26% YoY to $267 million. This included the $42 million one-time tax benefit, indicating underlying growth at 18% YoY. This division has been driving a 33% average YoY growth rate during the past 6 quarters, assisted greatly by the Maritime Life acquisition. Aside from the tax benefit in the quarter, higher experience gains, including favourable lapse, and earnings on surplus were the biggest earnings drivers. A change in asset mix had a $22 million reserve benefit. The negative impact of equity markets and ~$13 million less favourable claims experience in the Group business kept a lid on earnings growth this quarter.
Individual insurance profit of $115 million looked like a record level. Individual insurance sales at $57 million were just level with year ago sales. This is consistent with the message we have been receiving from independent distributors for some time, which confirms that Manulife is indeed maintaining significant price discipline in a buyers’ market.
Individual wealth contribution of $76 million was below the recent run-rate, but was still up 23% YoY. The chief earnings driver was a 12% YoY growth in funds under management to $37B from $33B in Q205, and this despite a 14% drop in traditional Premium & Deposits (largely segregated and mutual funds), probably driven instead by strong equity market performance YoY. Including the large 80% jump in new bank deposits to $889 million for Manulife Bank, overall wealth sales were level with year ago inflows.
The Domestic Group Benefit profit contribution of $76 million lined up on top of the $74 million 4-quarter trailing average. Sales, however, declined 45% YoY to $59 million, well below the four quarter trailing average of $90 MM. This is probably just a blip in a rather lumpy series – we do know the Manulife won the Rogers account which drops in next quarter, likely making up the sales shortfall this quarter by a multiple thereof. We have factored overall domestic run-rate earnings roughly level with this quarter in the second half of 2006.
Asia and Japan Profit Up 66% YoY (19% of Total Net Income)
Net income of USD$178 million compared to USD$107 million in Q205. A&J benefited from a variety of positive items in Q206. Japan experienced a USD$29 million gain related to the term extension for portfolio duration as well as reduced equity exposure. The Japan division also had favourable mortality, expense and investment gains activity, while Hong Kong had exceptionally strong wealth revenue momentum. The division generated 17% growth in premium and deposits and 22% growth in total funds under management. Insurance sales were down 9% YoY, largely driven by a 25% drop in Japan related to a change in reporting methodology and lower sales agent count. Suffice to say that insurance is not the incremental earnings driver in Asia, yet. Alternatively, wealth sales leapt 67%, mainly on Hong Kong and Other Asia – Japan VA sales of ~10% YoY reflected steady but moderating growth. The Japan VA sales will likely take a brief one to two quarter pause, expected to dip ~30% next quarter as the voluntary sales suspension takes hold. However, Manulife already plans another freshened product introduction for September, which may well keep the sales slowdown short-lived. Management assured that all is very well with its Bank of Tokyo partnership, and we are hearing the same directly from Japan sources.
Hong Kong grew its net income contribution 30% YoY, on a 228% lift in mutual fund sales, and group pension sales growth of 95%. Japan earnings of $92 million were near record-high divisional levels, reflecting the aforementioned gain and favourable experience. We think earnings for the Asia & Japan division will likely pull back about 10-15% next quarter.
Reinsurance Profit Declines to $43 Million (4% of Total)
While not a bad result overall, weak claims experience marred the division’s improved profit scale related to higher attachment points in the catastrophe business post the Hurricane season. We think earnings in this division will rise in future quarters, absent any $25B+ hurricane disasters.
Corporate and Other Profit Falls to $18 million
Lower investment income on the Manulife surplus, a $19 million hit for basis change charges in Japan and a $15 million hit for recalibration on the deferred tax asset all combined to cut YoY profit contribution by CAD$72 million. This will likely rebound in future quarters.
Individual wealth contribution of $76 million was below the recent run-rate, but was still up 23% YoY. The chief earnings driver was a 12% YoY growth in funds under management to $37B from $33B in Q205, and this despite a 14% drop in traditional Premium & Deposits (largely segregated and mutual funds), probably driven instead by strong equity market performance YoY. Including the large 80% jump in new bank deposits to $889 million for Manulife Bank, overall wealth sales were level with year ago inflows.
The Domestic Group Benefit profit contribution of $76 million lined up on top of the $74 million 4-quarter trailing average. Sales, however, declined 45% YoY to $59 million, well below the four quarter trailing average of $90 MM. This is probably just a blip in a rather lumpy series – we do know the Manulife won the Rogers account which drops in next quarter, likely making up the sales shortfall this quarter by a multiple thereof. We have factored overall domestic run-rate earnings roughly level with this quarter in the second half of 2006.
Asia and Japan Profit Up 66% YoY (19% of Total Net Income)
Net income of USD$178 million compared to USD$107 million in Q205. A&J benefited from a variety of positive items in Q206. Japan experienced a USD$29 million gain related to the term extension for portfolio duration as well as reduced equity exposure. The Japan division also had favourable mortality, expense and investment gains activity, while Hong Kong had exceptionally strong wealth revenue momentum. The division generated 17% growth in premium and deposits and 22% growth in total funds under management. Insurance sales were down 9% YoY, largely driven by a 25% drop in Japan related to a change in reporting methodology and lower sales agent count. Suffice to say that insurance is not the incremental earnings driver in Asia, yet. Alternatively, wealth sales leapt 67%, mainly on Hong Kong and Other Asia – Japan VA sales of ~10% YoY reflected steady but moderating growth. The Japan VA sales will likely take a brief one to two quarter pause, expected to dip ~30% next quarter as the voluntary sales suspension takes hold. However, Manulife already plans another freshened product introduction for September, which may well keep the sales slowdown short-lived. Management assured that all is very well with its Bank of Tokyo partnership, and we are hearing the same directly from Japan sources.
Hong Kong grew its net income contribution 30% YoY, on a 228% lift in mutual fund sales, and group pension sales growth of 95%. Japan earnings of $92 million were near record-high divisional levels, reflecting the aforementioned gain and favourable experience. We think earnings for the Asia & Japan division will likely pull back about 10-15% next quarter.
Reinsurance Profit Declines to $43 Million (4% of Total)
While not a bad result overall, weak claims experience marred the division’s improved profit scale related to higher attachment points in the catastrophe business post the Hurricane season. We think earnings in this division will rise in future quarters, absent any $25B+ hurricane disasters.
Corporate and Other Profit Falls to $18 million
Lower investment income on the Manulife surplus, a $19 million hit for basis change charges in Japan and a $15 million hit for recalibration on the deferred tax asset all combined to cut YoY profit contribution by CAD$72 million. This will likely rebound in future quarters.
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TD Newcrest, 4 August 2006
Impact
Neutral. We are not going to react to MFC’s weaker than expected operating results by lowering estimates and our target price. What the quarter, though, definitely highlighted was that MFC’s beta sensitivity is high, and has increased. As highlighted in our July 25, 2006 report “Wealth Management: These are not Simply Lifecos”, the group’s reliance on equity markets has increased, and while we believe this is good in the long-term, market gyrations can negatively impact short-term earnings results. We continue to believe MFC’s superior growth prospects, leverage from excess capital and potential for accretive acquisitions command a premium valuation. We are maintaining our $42 price target and Action List BUY rating.
Details
• Earnings Could Have Been Lower
In the above noted report, we concluded that MFC is at the high end of equity market sensitivity relative to its Canadian Lifeco peers. It seems now that we may have under-estimated the extent to which equity market movements can impact MFC’s earnings. Earnings could have been even lower than reported since poor equity market movements had a $107 million pre-tax negative impact (or roughly $0.05 per share after tax) on MFC’s seg fund reserves in Q2. Rather than incur a charge to remain at its Q1/06 CTE level (a measure of reserve adequacy), MFC allowed the CTE level to fall to the low end of its 60-80 acceptability range. In contrast, SLF conservatively chose to increase its seg fund reserves during Q2 and maintained a CTE level at the high end of the range.
Aside from the impact on seg fund reserves, poor equity markets decreased earnings by $40 million. While in the long run, we have a positive bias towards Lifeco wealth management businesses (whose performance is equity-market driven), we believe investors should be aware of the growing beta sensitivity these businesses
create.
• Sales Results Fall Below MFC’s Standards
We can point to several divisions where MFC delivered very strong exceptional organic growth, including U.S. Life Insurance, 401(k) and mutual funds and Hong Kong wealth. However, several divisions (see Exhibit 2) failed to meet the standards we have come to expect from MFC. Though it’s not included in Exhibit 2, we would also mention the U.S. Variable Annuity (VA) segment’s sequential sales growth appears to have slowed. In comparison, competitors such as Met Life and Prudential enjoyed exceptional sequential Q2 growth. Management indicates that it is sticking to pricing discipline in some markets while at the same time is refreshing some of its products in order to improve sales results. We hope for a rebound in Q3, albeit that we agree with the company’s strategy to focus on profitable products.
• Value of New Business (VNB) Growth Continues
While sales growth seems to be losing momentum, VNB growth (an indicator of future profitability) was again very strong this quarter. VNB increased 46% yr/yr; for wealth products specifically, which we believe generate higher margins, VNB was up even more, at 53%. While sales this quarter were below MFC’s high standards, we are pleased to see VNB growth has not suffered; furthermore, MFC’s 46% growth rate compares to 9% at Sun Life and 23% at Industrial Alliance. We believe this statistic is an important factor why investors should be willing to pay a relative premium for MFC’s shares.
• Rising Interest Rates Could Boost Earnings in Q4
With interest rates trending upwards since the start of the year, management has indicated that a positive impact (through reserve releases into earnings) could be felt when it performs its year-end actuarial review of life insurance reserves. Management won’t quantify the impact on earnings, however stated that the figure will be noticeable. This quarter, rising interest rates benefited wealth management earnings (where actuarial reserves are reviewed quarterly) by $20 million on a pre-tax basis. We note that life insurance reserves are much more sensitive to interest rates than wealth management reserves are. In 2005, MFC increased its reserves by $338 million (pre-tax) to reflect low interest rates.
• Comments on Slowdown in Japanese VA Sales
MFC suspended sales of a popular VA product it launched last November. Management has indicated that there is ongoing dialogue with the Japanese regulator about the tax treatment of this product, however, it has started designing a new product to be launched in Q4 that should satisfy the regulator’s concerns. Nonetheless, we expect a meaningful drop-off in Q3 sales due to this issue.
• Will MFC Continue its Above Average Buyback Pace
We do not believe MFC will maintain a $1 billion/quarter buyback pace, however, it still holds over $3 billion in excess capital that provides plenty of support for its stock.
• Justification of Target Price
Our price target equates to 15x our 2007E EPS, implying a 2 times valuation multiple premium to what we use for SLF and GWO. We believe the following elements justify the premium: (1) if MFC makes a large acquisition, we believe its stock price will benefit; (2) aggressive buy back program; (3) growth potential in Japan and other Asian regions; and, (4) in our view, it has the best long-term growth prospects of the group.
• Key Risks to Target Price
(1) U.S. dollar deterioration relative to the Canadian dollar; (2) confusion with US GAAP reconciliation; (3) sudden interest rate spikes; (4) significant downturn in equity markets; (5) regulatory scrutiny into industry sales practices; (6) potential for underpriced business translating into margin deterioration; and, (7) inability to source meaningful acquisitions
• Investment Conclusion
Given the weaker than expected earnings performance and the company allowing seg fund reserve levels to fall, we feel there is appropriate ammunition for detractors to view the quarter as a negative one, and as a result, we expect the stock to experience a little weakness in the trading days ahead. We prefer to take a long term view. We believe MFC’s strong, global wealth management position is a significant positive, as it should provide the company a platform for superior earnings growth. Combined with excellent positions in its insurance operations, and considerable financial flexibility, we expect the stock to outperform other Canadian financial services stocks. We believe long-term investors should take advantage of share price weakness to buy the stock.
Impact
Neutral. We are not going to react to MFC’s weaker than expected operating results by lowering estimates and our target price. What the quarter, though, definitely highlighted was that MFC’s beta sensitivity is high, and has increased. As highlighted in our July 25, 2006 report “Wealth Management: These are not Simply Lifecos”, the group’s reliance on equity markets has increased, and while we believe this is good in the long-term, market gyrations can negatively impact short-term earnings results. We continue to believe MFC’s superior growth prospects, leverage from excess capital and potential for accretive acquisitions command a premium valuation. We are maintaining our $42 price target and Action List BUY rating.
Details
• Earnings Could Have Been Lower
In the above noted report, we concluded that MFC is at the high end of equity market sensitivity relative to its Canadian Lifeco peers. It seems now that we may have under-estimated the extent to which equity market movements can impact MFC’s earnings. Earnings could have been even lower than reported since poor equity market movements had a $107 million pre-tax negative impact (or roughly $0.05 per share after tax) on MFC’s seg fund reserves in Q2. Rather than incur a charge to remain at its Q1/06 CTE level (a measure of reserve adequacy), MFC allowed the CTE level to fall to the low end of its 60-80 acceptability range. In contrast, SLF conservatively chose to increase its seg fund reserves during Q2 and maintained a CTE level at the high end of the range.
Aside from the impact on seg fund reserves, poor equity markets decreased earnings by $40 million. While in the long run, we have a positive bias towards Lifeco wealth management businesses (whose performance is equity-market driven), we believe investors should be aware of the growing beta sensitivity these businesses
create.
• Sales Results Fall Below MFC’s Standards
We can point to several divisions where MFC delivered very strong exceptional organic growth, including U.S. Life Insurance, 401(k) and mutual funds and Hong Kong wealth. However, several divisions (see Exhibit 2) failed to meet the standards we have come to expect from MFC. Though it’s not included in Exhibit 2, we would also mention the U.S. Variable Annuity (VA) segment’s sequential sales growth appears to have slowed. In comparison, competitors such as Met Life and Prudential enjoyed exceptional sequential Q2 growth. Management indicates that it is sticking to pricing discipline in some markets while at the same time is refreshing some of its products in order to improve sales results. We hope for a rebound in Q3, albeit that we agree with the company’s strategy to focus on profitable products.
• Value of New Business (VNB) Growth Continues
While sales growth seems to be losing momentum, VNB growth (an indicator of future profitability) was again very strong this quarter. VNB increased 46% yr/yr; for wealth products specifically, which we believe generate higher margins, VNB was up even more, at 53%. While sales this quarter were below MFC’s high standards, we are pleased to see VNB growth has not suffered; furthermore, MFC’s 46% growth rate compares to 9% at Sun Life and 23% at Industrial Alliance. We believe this statistic is an important factor why investors should be willing to pay a relative premium for MFC’s shares.
• Rising Interest Rates Could Boost Earnings in Q4
With interest rates trending upwards since the start of the year, management has indicated that a positive impact (through reserve releases into earnings) could be felt when it performs its year-end actuarial review of life insurance reserves. Management won’t quantify the impact on earnings, however stated that the figure will be noticeable. This quarter, rising interest rates benefited wealth management earnings (where actuarial reserves are reviewed quarterly) by $20 million on a pre-tax basis. We note that life insurance reserves are much more sensitive to interest rates than wealth management reserves are. In 2005, MFC increased its reserves by $338 million (pre-tax) to reflect low interest rates.
• Comments on Slowdown in Japanese VA Sales
MFC suspended sales of a popular VA product it launched last November. Management has indicated that there is ongoing dialogue with the Japanese regulator about the tax treatment of this product, however, it has started designing a new product to be launched in Q4 that should satisfy the regulator’s concerns. Nonetheless, we expect a meaningful drop-off in Q3 sales due to this issue.
• Will MFC Continue its Above Average Buyback Pace
We do not believe MFC will maintain a $1 billion/quarter buyback pace, however, it still holds over $3 billion in excess capital that provides plenty of support for its stock.
• Justification of Target Price
Our price target equates to 15x our 2007E EPS, implying a 2 times valuation multiple premium to what we use for SLF and GWO. We believe the following elements justify the premium: (1) if MFC makes a large acquisition, we believe its stock price will benefit; (2) aggressive buy back program; (3) growth potential in Japan and other Asian regions; and, (4) in our view, it has the best long-term growth prospects of the group.
• Key Risks to Target Price
(1) U.S. dollar deterioration relative to the Canadian dollar; (2) confusion with US GAAP reconciliation; (3) sudden interest rate spikes; (4) significant downturn in equity markets; (5) regulatory scrutiny into industry sales practices; (6) potential for underpriced business translating into margin deterioration; and, (7) inability to source meaningful acquisitions
• Investment Conclusion
Given the weaker than expected earnings performance and the company allowing seg fund reserve levels to fall, we feel there is appropriate ammunition for detractors to view the quarter as a negative one, and as a result, we expect the stock to experience a little weakness in the trading days ahead. We prefer to take a long term view. We believe MFC’s strong, global wealth management position is a significant positive, as it should provide the company a platform for superior earnings growth. Combined with excellent positions in its insurance operations, and considerable financial flexibility, we expect the stock to outperform other Canadian financial services stocks. We believe long-term investors should take advantage of share price weakness to buy the stock.
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Bloomberg, 4 August 2006
Manulife Financial Corp. was raised to ``buy 1'' from ``neutral 1'' by analyst Jason Bilodeau at UBS. The price target is C$42.00 per share.
Manulife Financial Corp. was raised to ``buy 1'' from ``neutral 1'' by analyst Jason Bilodeau at UBS. The price target is C$42.00 per share.
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The Globe and Mail, Sinclair Stewart, 4 August 2006
Manulife Financial Corp. bought back almost $1-billion worth of its own stock in just three months, contributing to a torrid spate of buyback activity recently among some of North America's largest and most cash-rich companies.
Canada's biggest insurer offered details of the considerable share repurchase yesterday, when it reported its second-quarter results. Profit for the quarter increased 14 per cent to $952-million or 60 cents for a fully diluted share, compared with $835-million or 52 cents in the same period of 2005.
The financial results demonstrate just how aggressively Manulife has been returning its stockpile of excess cash to investors. The company bought back 25.7 million shares during the quarter at a cost of $933-million: that's almost as much as its quarterly profit, and more than the $761-million it shelled out for repurchases in all of last year. So far in 2006, Manulife has made approximately $1.9-billion in profit, and returned over $1.7-billion to shareholders through buybacks and dividends.
Buybacks have suddenly elbowed their way into vogue amid a long period of solid economic conditions and a positive credit environment. Balance sheets are blemish-free, profit is climbing, and companies are suddenly finding themselves sitting on large cash hoards without a lot of places to spend it.
Microsoft Corp. unveiled a staggering $40-billion (U.S.) buyback plan last month, capping a series of large repurchasing activity by such companies as Cisco Systems Inc., eBay Inc., Exxon and Citigroup.
"We're bullish on the future of our business," Manulife chief executive officer Dominic D'Alessandro told analysts on a conference call yesterday, explaining the rationale for such a large buyback. He also pointed out that Manulife has weathered the effects of a higher Canadian dollar, choppy markets and the integration of its John Hancock Financial Services Inc. purchase, and still managed to accumulate more than $3-billion (Canadian) worth of excess capital.
"Why wait until we have a $5-billion excess capital problem?" he asked.
Executives often undertake buybacks when they believe their company's shares are undervalued. They provide a more flexible means of capital management than dividends.
Excess capital has been a major concern in Canada's financial industry, especially for the banks, which can't find enough places to spend it. Some have made U.S. acquisitions, but these are relatively scarce, and cash continues to pile up on the balance sheet.
In the United States, according to a June report from rating agency Standard & Poor's Corp., buybacks have surged 22 per cent in the first quarter of this year among members of the S&P 500 benchmark index, with spending topping $100-billion (U.S.). The Toronto Stock Exchange does not track similar figures in Canada, although anecdotally, industry watchers have also noticed an upswing here.
Analysts who track Manulife suggested the insurer could be using the unusually large buyback to help prop up share earnings at a time when growth is slowing, or merely deploying their cash when no major acquisitions are looming.
Mr. D'Alessandro didn't talk about prospective deals, but reiterated on the conference call that the insurer does not need to make an acquisition right now.
Manulife shares slipped 48 cents (Canadian) yesterday on the TSX, closing at $35.17. The company met consensus profit estimates of 60 cents a share, although some analysts believed that number was inflated by a penny or two because of a lower tax rate.
Manulife Financial Corp. bought back almost $1-billion worth of its own stock in just three months, contributing to a torrid spate of buyback activity recently among some of North America's largest and most cash-rich companies.
Canada's biggest insurer offered details of the considerable share repurchase yesterday, when it reported its second-quarter results. Profit for the quarter increased 14 per cent to $952-million or 60 cents for a fully diluted share, compared with $835-million or 52 cents in the same period of 2005.
The financial results demonstrate just how aggressively Manulife has been returning its stockpile of excess cash to investors. The company bought back 25.7 million shares during the quarter at a cost of $933-million: that's almost as much as its quarterly profit, and more than the $761-million it shelled out for repurchases in all of last year. So far in 2006, Manulife has made approximately $1.9-billion in profit, and returned over $1.7-billion to shareholders through buybacks and dividends.
Buybacks have suddenly elbowed their way into vogue amid a long period of solid economic conditions and a positive credit environment. Balance sheets are blemish-free, profit is climbing, and companies are suddenly finding themselves sitting on large cash hoards without a lot of places to spend it.
Microsoft Corp. unveiled a staggering $40-billion (U.S.) buyback plan last month, capping a series of large repurchasing activity by such companies as Cisco Systems Inc., eBay Inc., Exxon and Citigroup.
"We're bullish on the future of our business," Manulife chief executive officer Dominic D'Alessandro told analysts on a conference call yesterday, explaining the rationale for such a large buyback. He also pointed out that Manulife has weathered the effects of a higher Canadian dollar, choppy markets and the integration of its John Hancock Financial Services Inc. purchase, and still managed to accumulate more than $3-billion (Canadian) worth of excess capital.
"Why wait until we have a $5-billion excess capital problem?" he asked.
Executives often undertake buybacks when they believe their company's shares are undervalued. They provide a more flexible means of capital management than dividends.
Excess capital has been a major concern in Canada's financial industry, especially for the banks, which can't find enough places to spend it. Some have made U.S. acquisitions, but these are relatively scarce, and cash continues to pile up on the balance sheet.
In the United States, according to a June report from rating agency Standard & Poor's Corp., buybacks have surged 22 per cent in the first quarter of this year among members of the S&P 500 benchmark index, with spending topping $100-billion (U.S.). The Toronto Stock Exchange does not track similar figures in Canada, although anecdotally, industry watchers have also noticed an upswing here.
Analysts who track Manulife suggested the insurer could be using the unusually large buyback to help prop up share earnings at a time when growth is slowing, or merely deploying their cash when no major acquisitions are looming.
Mr. D'Alessandro didn't talk about prospective deals, but reiterated on the conference call that the insurer does not need to make an acquisition right now.
Manulife shares slipped 48 cents (Canadian) yesterday on the TSX, closing at $35.17. The company met consensus profit estimates of 60 cents a share, although some analysts believed that number was inflated by a penny or two because of a lower tax rate.
Dow Jones Newswires, Monica Gutschi, 3 August 2006
Despite weak equity markets and a hefty currency-exchange impact, Manulife Financial Corp. was able to drive its second-quarter earnings to a record C$960 million, a 14% increase.
"We feel very good about our business," chief executive Dominic D'Alessandro said on a conference call.
Earnings in the period totalled 60 Canadian cents a share, up from C$839 million or 52 Canadian cents a year earlier, and right in line with a Thomson First Call mean earnings estimate.
The Canadian insurance giant was also able to report return on common shareholders' equity of 16.3%, an increase from 14.3% last year and above its 16% goal.
Results were boosted by changes in Canada's corporate tax rate, which were only partly offset by a charge to raise reserves for segregated fund guarantees.
On the flip side, the strengthening of the Canadian dollar cut into earnings by about C$87 million. And the company said weaker equity markets trimmed C$40 million off the bottom line.
Overall, however, analysts said Manulife met expectations in the quarter.
"All in, another steady quarter," Scotia Capital said in a note, highlighting the "excellent top-line growth" in the U.S. Variable annuity sales rose 41%, individual life insurance sales rose 34%, long-term care sales rose 44%, 401(k) sales grew 13% and mutual fund sales increased 69%, Scotia said, adding it expects the pace to slow later in the year.
Chief Financial Officer Peter Rubenovitch noted the strong increase in life insurance sales has propelled John Hancock, the company's U.S. division, to the top spot in market share compared to its number 7 position a year ago.
Canadian sales were flat amid intense competition particularly in the Universal Life segment.
Net income at the U.S. insurance division fell to C$127 millino from C$157 million a year earlier despite the sales growth, primarily due to the drop in equity markets during the quarter and the foreign-exchange impact. However, net income at U.S. Wealth Management rose to C$301 million from C$249 million a year ago.
Net income at its Canadian business soared to C$267 millon from C$191 million a year earlier, although C$42 millon of the increase was due to a drop in Canadian tax rates. Nevertheless, excluding the tax gain, income rose 18% in the division in part due to changes in the asset mix and investment profile of the individual life insurance segment.
Even with the hefty bite taken by the stronger Canadian dollar, the Asia and Japan Division reported net income of C$199 million, up 51% from C$132 million a year earlier, primarily on actuarial changes resulting from lower equity exposure there.
Manulife said it repurchased 25.7 million common shares in the second quarter. Including the dividend, D'Alessandro said the company had returned more than C$1.2 billion in capital to shareholders in the period. The company continues to hold more than C$3 billion in excess capital.
Despite weak equity markets and a hefty currency-exchange impact, Manulife Financial Corp. was able to drive its second-quarter earnings to a record C$960 million, a 14% increase.
"We feel very good about our business," chief executive Dominic D'Alessandro said on a conference call.
Earnings in the period totalled 60 Canadian cents a share, up from C$839 million or 52 Canadian cents a year earlier, and right in line with a Thomson First Call mean earnings estimate.
The Canadian insurance giant was also able to report return on common shareholders' equity of 16.3%, an increase from 14.3% last year and above its 16% goal.
Results were boosted by changes in Canada's corporate tax rate, which were only partly offset by a charge to raise reserves for segregated fund guarantees.
On the flip side, the strengthening of the Canadian dollar cut into earnings by about C$87 million. And the company said weaker equity markets trimmed C$40 million off the bottom line.
Overall, however, analysts said Manulife met expectations in the quarter.
"All in, another steady quarter," Scotia Capital said in a note, highlighting the "excellent top-line growth" in the U.S. Variable annuity sales rose 41%, individual life insurance sales rose 34%, long-term care sales rose 44%, 401(k) sales grew 13% and mutual fund sales increased 69%, Scotia said, adding it expects the pace to slow later in the year.
Chief Financial Officer Peter Rubenovitch noted the strong increase in life insurance sales has propelled John Hancock, the company's U.S. division, to the top spot in market share compared to its number 7 position a year ago.
Canadian sales were flat amid intense competition particularly in the Universal Life segment.
Net income at the U.S. insurance division fell to C$127 millino from C$157 million a year earlier despite the sales growth, primarily due to the drop in equity markets during the quarter and the foreign-exchange impact. However, net income at U.S. Wealth Management rose to C$301 million from C$249 million a year ago.
Net income at its Canadian business soared to C$267 millon from C$191 million a year earlier, although C$42 millon of the increase was due to a drop in Canadian tax rates. Nevertheless, excluding the tax gain, income rose 18% in the division in part due to changes in the asset mix and investment profile of the individual life insurance segment.
Even with the hefty bite taken by the stronger Canadian dollar, the Asia and Japan Division reported net income of C$199 million, up 51% from C$132 million a year earlier, primarily on actuarial changes resulting from lower equity exposure there.
Manulife said it repurchased 25.7 million common shares in the second quarter. Including the dividend, D'Alessandro said the company had returned more than C$1.2 billion in capital to shareholders in the period. The company continues to hold more than C$3 billion in excess capital.
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Bloomberg, 3 August 2006
Manulife Financial Corp., Canada's biggest insurer, said second-quarter profit rose 14 percent to a record on higher life insurance and asset-management revenue in Canada and Asia.
Net income rose to C$960 million ($852 million), or 60 cents a share, from C$839 million, or 52 cents, a year ago, the Toronto-based company said today. Revenue rose 0.7 percent to C$8 billion.
Chief Executive Officer Dominic D'Alessandro is expanding in Asia by opening offices and hiring more staff in China and Hong Kong and buying insurers in the Philippines. Profit from the Asian unit, which also includes Japan and Indonesia, increased 51 percent to C$199 million.
``I think it's fairly important that they make good headways into these emerging markets,'' said Ian Nakamoto, director of research at MacDougall, MacDougall & Mactier Inc. in Toronto, which manages the equivalent of about $3.2 billion in assets, including Manulife shares.
Asian earnings were led by variable annuity sales in Japan and increased money management fees from Hong Kong, Manulife said. Wealth management sales in Hong Kong more than tripled to $226 million. Profit growth was tempered by gains in the Canadian dollar against foreign currencies, which lowered overall profit by C$87 million.
Profit from Canada climbed 40 percent to C$267 million because of a reduction in tax rates and higher asset-management sales. Total premiums and deposits rose 10 percent to C$15.9 billion, and net income rose for a 19th straight quarter.
Earnings from the U.S. asset-management, which includes John Hancock Financial, climbed 21 percent to C$301 million. U.S. insurance profit fell 19 percent to C$127 million.
``They're being helped a lot by the acquisition in the U.S. of John Hancock,'' said Stephen Gauthier, who holds Manulife shares among the assets he manages as partner at investment firm Gauthier & Cie. in Montreal. ``They've done a good job integrating it and are growing revenues faster than before.''
National Bank Financial analyst Robert Wessel said that the company earned 56 cents a share excluding one-time items, below his estimate of 58 cents. Manulife was expected to earn 60 cents a share, according to the average estimate of 12 analysts polled by Thomson Financial, which didn't say how it comprised its estimates.
Manulife's ``medium-term outlook remains among the best in sector with diverse geographic exposure, including high-growth Asia,'' UBS Canada analyst Jason Bilodeau wrote today in a note to investors. Bilodeau said profit fell short of his estimate of 62 cents a share.
Manulife returned C$1.2 billion to shareholders in the quarter through dividends and the repurchasing of 25.7 million shares. D'Alessandro said the insurer doesn't have to make acquisitions to expand its business and that it's ``unlikely'' the Canadian dollar will continue on its current pace of gains. The Canadian dollar has risen 3.3 percent this year.
The company has more than C$3 billion in cash that could be used for acquisitions, said Chief Financial Officer Peter Rubenovitch.
Manulife is the last of Canada's three largest insurers to report results. Last week, Sun Life Financial Inc. said profit rose 7.3 percent to a record C$512 million, or 88 cents a share. Great-West Lifeco Inc. reported yesterday that profit rose 3.4 percent to C$461 million, or 51 cents a share.
Sun Life also benefited from its Asian expansion, as profit from that unit almost doubled to C$31 million after the firm bought CMG Asia Ltd. and CommServe Financial Ltd.
Manulife Financial Corp., Canada's biggest insurer, said second-quarter profit rose 14 percent to a record on higher life insurance and asset-management revenue in Canada and Asia.
Net income rose to C$960 million ($852 million), or 60 cents a share, from C$839 million, or 52 cents, a year ago, the Toronto-based company said today. Revenue rose 0.7 percent to C$8 billion.
Chief Executive Officer Dominic D'Alessandro is expanding in Asia by opening offices and hiring more staff in China and Hong Kong and buying insurers in the Philippines. Profit from the Asian unit, which also includes Japan and Indonesia, increased 51 percent to C$199 million.
``I think it's fairly important that they make good headways into these emerging markets,'' said Ian Nakamoto, director of research at MacDougall, MacDougall & Mactier Inc. in Toronto, which manages the equivalent of about $3.2 billion in assets, including Manulife shares.
Asian earnings were led by variable annuity sales in Japan and increased money management fees from Hong Kong, Manulife said. Wealth management sales in Hong Kong more than tripled to $226 million. Profit growth was tempered by gains in the Canadian dollar against foreign currencies, which lowered overall profit by C$87 million.
Profit from Canada climbed 40 percent to C$267 million because of a reduction in tax rates and higher asset-management sales. Total premiums and deposits rose 10 percent to C$15.9 billion, and net income rose for a 19th straight quarter.
Earnings from the U.S. asset-management, which includes John Hancock Financial, climbed 21 percent to C$301 million. U.S. insurance profit fell 19 percent to C$127 million.
``They're being helped a lot by the acquisition in the U.S. of John Hancock,'' said Stephen Gauthier, who holds Manulife shares among the assets he manages as partner at investment firm Gauthier & Cie. in Montreal. ``They've done a good job integrating it and are growing revenues faster than before.''
National Bank Financial analyst Robert Wessel said that the company earned 56 cents a share excluding one-time items, below his estimate of 58 cents. Manulife was expected to earn 60 cents a share, according to the average estimate of 12 analysts polled by Thomson Financial, which didn't say how it comprised its estimates.
Manulife's ``medium-term outlook remains among the best in sector with diverse geographic exposure, including high-growth Asia,'' UBS Canada analyst Jason Bilodeau wrote today in a note to investors. Bilodeau said profit fell short of his estimate of 62 cents a share.
Manulife returned C$1.2 billion to shareholders in the quarter through dividends and the repurchasing of 25.7 million shares. D'Alessandro said the insurer doesn't have to make acquisitions to expand its business and that it's ``unlikely'' the Canadian dollar will continue on its current pace of gains. The Canadian dollar has risen 3.3 percent this year.
The company has more than C$3 billion in cash that could be used for acquisitions, said Chief Financial Officer Peter Rubenovitch.
Manulife is the last of Canada's three largest insurers to report results. Last week, Sun Life Financial Inc. said profit rose 7.3 percent to a record C$512 million, or 88 cents a share. Great-West Lifeco Inc. reported yesterday that profit rose 3.4 percent to C$461 million, or 51 cents a share.
Sun Life also benefited from its Asian expansion, as profit from that unit almost doubled to C$31 million after the firm bought CMG Asia Ltd. and CommServe Financial Ltd.
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RBC Capital Markets, 3 August 2006
First Impressions
• Q2 Light by 2¢ Versus Consensus. Manulife posted 60¢ EPS, up 15% YoY from 52¢ in Q205. Excluding a 2¢ 1-time tax benefit, underlying EPS was only 58¢. However, underlying growth excluding the 2¢ tax gain and a 5.5¢ foreign exchange drag was an impressive 22% YoY. Compare to 7% YoY EPS growth for IAG, 0% for Sun Life (6% excl. F/X) and 3% for Great-West Life (11% excl F/X). The underlying tax rate at 27.5% matched our 27% modeled estimate, and was still 25% including the 1-time tax benefits. (Sun Life used 16%, 1% with tax benefits). The buyback influence was as we had modeled.
• Good Discipline in Tough Markets. Of the Canadian lifecos, Manulife again delivered the strongest underlying EPS growth by a very wide margin. Although we do see this as a slight EPS miss versus consensus, in our view, it is less serious than for others. In part, we think a key difference is that Manulife dialed back its insurance sales and reduced “sales strain” 25% YoY, in the interest of price discipline. Conversely, all three Canadian peers had problematic strain this quarter, we think.
• Sales Solid, Not Stellar. Sales were up double digit plus in many key markets. Broadly, we had been looking for even more growth – but it seems competition has heated up, pricing has tightened and Manulife is holding back in certain regions such as domestic life and perhaps in U.S. life. U.S. insurance sales at US$226MM were still up 35% YoY from US$167MM in Q205. U.S. VA sales of US$2.9B were still up 40% YoY versus US$2.0B MM in Q205. Japan VA sales at US$745 MM up only 10% YoY from US$679 MM in Q205 were in line with our expectations, reflecting better competitors. On the other hand, U.S. mutual fund sales were indeed stellar, at US$719 MM vs US$74 MM in Q205. Mutual fund sales in Hong Kong were also stellar strong, more than doubling YoY.
• Sources of Earnings Confirms High-Quality Momentum. Expected profit from in-force remained in a clear up-trend, growing 14% YoY. Earnings on surplus, however, is steadily declining as investment yields and excess surplus both drop (i.e., buybacks). This is not a bad thing, in our view, signaling higher quality insurance earnings. Sales strain of $60MM edged below the $62MM 4-qtr trailing average, and was down 25% YoY.
First Impressions
• Q2 Light by 2¢ Versus Consensus. Manulife posted 60¢ EPS, up 15% YoY from 52¢ in Q205. Excluding a 2¢ 1-time tax benefit, underlying EPS was only 58¢. However, underlying growth excluding the 2¢ tax gain and a 5.5¢ foreign exchange drag was an impressive 22% YoY. Compare to 7% YoY EPS growth for IAG, 0% for Sun Life (6% excl. F/X) and 3% for Great-West Life (11% excl F/X). The underlying tax rate at 27.5% matched our 27% modeled estimate, and was still 25% including the 1-time tax benefits. (Sun Life used 16%, 1% with tax benefits). The buyback influence was as we had modeled.
• Good Discipline in Tough Markets. Of the Canadian lifecos, Manulife again delivered the strongest underlying EPS growth by a very wide margin. Although we do see this as a slight EPS miss versus consensus, in our view, it is less serious than for others. In part, we think a key difference is that Manulife dialed back its insurance sales and reduced “sales strain” 25% YoY, in the interest of price discipline. Conversely, all three Canadian peers had problematic strain this quarter, we think.
• Sales Solid, Not Stellar. Sales were up double digit plus in many key markets. Broadly, we had been looking for even more growth – but it seems competition has heated up, pricing has tightened and Manulife is holding back in certain regions such as domestic life and perhaps in U.S. life. U.S. insurance sales at US$226MM were still up 35% YoY from US$167MM in Q205. U.S. VA sales of US$2.9B were still up 40% YoY versus US$2.0B MM in Q205. Japan VA sales at US$745 MM up only 10% YoY from US$679 MM in Q205 were in line with our expectations, reflecting better competitors. On the other hand, U.S. mutual fund sales were indeed stellar, at US$719 MM vs US$74 MM in Q205. Mutual fund sales in Hong Kong were also stellar strong, more than doubling YoY.
• Sources of Earnings Confirms High-Quality Momentum. Expected profit from in-force remained in a clear up-trend, growing 14% YoY. Earnings on surplus, however, is steadily declining as investment yields and excess surplus both drop (i.e., buybacks). This is not a bad thing, in our view, signaling higher quality insurance earnings. Sales strain of $60MM edged below the $62MM 4-qtr trailing average, and was down 25% YoY.
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BMO Capital Markets, 3 August 2006
Manulife reported fully diluted EPS of $0.60 versus $0.54 last year and consensus of $0.60. Overall, earnings growth was well diversified across the company and sales results also remain very healthy across jurisdictions. Pre-tax profits rose 12% and a lower tax rate helped drive earnings growth to 14% in the quarter. In-force profits rose a very strong 14% to $776 million and Manulife continues to build its book of business nicely. While the tax rate was lower than last year, there were some offsetting items, particularly a 40% decline of C$44 million in earnings from reinsurance & corporate and it was 45% below our estimate. ROE was an impressive 16.3% and the company repurchased $1.2 billion in stock during the quarter. Earnings in Hong Kong rose 31% to US$72 million and in Japan increased 136% to US$92 million from a relatively weak Q2/05. Both results are ahead of our expectations. Q2/06 earnings also benefited from lower CTE levels on segregated funds. The CTE level fell to 68 from 73 in Q2/05 and 76 in Q1/06. Overall, another good quarter from MFC and the shares remain Outperform rated.
;
Manulife reported fully diluted EPS of $0.60 versus $0.54 last year and consensus of $0.60. Overall, earnings growth was well diversified across the company and sales results also remain very healthy across jurisdictions. Pre-tax profits rose 12% and a lower tax rate helped drive earnings growth to 14% in the quarter. In-force profits rose a very strong 14% to $776 million and Manulife continues to build its book of business nicely. While the tax rate was lower than last year, there were some offsetting items, particularly a 40% decline of C$44 million in earnings from reinsurance & corporate and it was 45% below our estimate. ROE was an impressive 16.3% and the company repurchased $1.2 billion in stock during the quarter. Earnings in Hong Kong rose 31% to US$72 million and in Japan increased 136% to US$92 million from a relatively weak Q2/05. Both results are ahead of our expectations. Q2/06 earnings also benefited from lower CTE levels on segregated funds. The CTE level fell to 68 from 73 in Q2/05 and 76 in Q1/06. Overall, another good quarter from MFC and the shares remain Outperform rated.
