29 November 2006

Scotia Capital Upgrades Sun Life

Scotia Capital, 29 November 2006

• We are rolling out our 2008E EPS estimates and increasing our share price targets for the Canadian lifecos - we forecast modest compression in forward multiple (from current 13.3x to 13x, in line with three year average) in part due to declining bond yields. Our share price targets imply an assumed average forward multiple for the group of 13x, down slightly from the current 13.3x, in part due to our expectation that long term bond yields will fall a little further by the end of 2007 (US 10-yr from 4.50% to 4.40%, and 10-year Canadas from 3.92% to 3.70%). Our 13x group average is in-line with the average over the last three years.

• MFC's premium to the group expected to continue to modestly compress, IAG's discount to the group expected to expand. GWO's premium to the group expected to remain constant. We expect modest compression in MFC's premium to the group on a forward P/E basis (from 5% to 4%, and closer to its 2% average) as the company's top-line growth rate, especially in the U.S., continues to decelerate from its exceptional 30%+ range in late 2005/early 2006 (when the premium to the group ran up to 12% peak in early 2006) and returns to levels closer to industry norm. We expect IAG's discount to the group to expand from its current 5% discount to a 7% discount, in part due to its higher sensitivity to low Canadian bond yields, and in part due to its higher sensitivity to volatile Canadian equity markets, and move closer to the 10% discount it has averaged to the group, excluding acquisitions, since 2000. We expect GWO's premium to the group to remain at its current 5%-6% range (still less than its 8% average premium since 2000), in part due to the potential for more bolt-on acquisitions, as well as its diversified earnings base and its strong market share in niche growth businesses with relatively high barriers to entry. Exhibit 1 outlines our targets and rationales.

• We are upgrading Sun Life to a 1-Sector Outperform from a 2-Sector Perform, primarily based on valuation. We believe Sun Life's valuation is especially attractive versus other Canadian lifecos. Trading at 12.4x NTM EPS, the stock is at a 7% discount to the group average (versus an average 2% discount over the last three years). See Exhibit 2.

• SLF's relative growth rate to the group has increased but its relative multiple to the group has decreased, presenting an attractive opportunity. We believe Sun Life's 10.5% estimated annual EPS growth from 2006E-2008E, versus the sector average at 11.8%, should justify something less than a 7% discount, especially given that the average discount was 2% from 2003-2006E, when Sun Life grew EPS 11% annually versus the sector average of 13%.

• SLF valuation and growth rate is particularly attractive versus the Canadian banks. As outlined in Exhibit 3, Sun Life's forward multiple versus the Canadian banks has declined to a 3-year low of 7% discount, versus its 2% average premium over the last three years. This combined with an 11% EPS growth in 2007, versus the banks at 9%, adds to the attractiveness.

• A fresh look to the management team is a positive to the SLF story. The recent hires of CFO Rick McKenney (former CFO of Genworth), Stephan Rajotte as President of SLF Asia (from MetLife International) and Dean Connor, EVP, responsible for UK, Reinsurance and International operations, bring lots of important and necessary outside experience to the company.

• With the unnecessary sense of urgency to do a deal now essentially out of the way, we believe the company can focus on improving fundamentals of the business. We feel the need to do a large transformational deal, and the associated risks thereof, has been a drag on SLF's valuation relative to the group. With this essentially behind us, we believe the company can re-focus on the business, and utilize its exceptional capital base to further enhance EPS through share buybacks, and further increase shareholder value though dividend increases.

• Payout ratio will likely climb to 35% with more and more share buybacks. An attractive 2.5% dividend yield, we look for the payout ratio to increase from its current 30% of 2007E EPS to 35%. In addition, we expect the company will continue to be active in buying back stock, buying back nearly 3% of its shares in 2007.

• We forecast 11.8% average EPS growth for the group through 2008. Exhibits 4, 5 and 6 outline our estimates, as well as the underlying assumptions. The currency assumptions are based on current estimates from Scotia Economics. We see upside in our estimates (1%-2%) should the Canadian dollar remain below US$0.90 through the end of 2008.

• Over the last five months banks have outperformed the lifecos by 10%, almost entirely due to relative multiple appreciation for the bank group, as the lifeco forward P/E premium to the banks fell from 10% to 0%, below its long term average of a 2% premium. We attribute part of the decline to the 60 bp fall in long bond yields in the U.S. and Canada, and the fact that the banks have been primary beneficiaries of a decline in resource based stocks and the income trust fall-out. With only minimal decline in bond yields (20 bp) expected by the end of 2007 we believe the decline in lifeco multiples versus the banks is all but complete. See exhibit 7.