Scotia Capital, 24 January 2007
• Canadian Lifecos – Moving To Overweight •
• Favourable macro environment. The macro environment continues to look good for our insurers. Currency rates are much more favourable than six months ago and continue to move in a direction that adds to our EPS estimates. Long-term interest rates appear to have stabilized, and with Scotia Economics forecasting both U.S. 10-year treasuries and government of Canada 10-year yields to generally remain at current levels through the middle of 2008, we see little in the way of headwinds due to declining long-term yields. U.S. equity markets, where the Canadian lifecos have the majority of their equity market risk, appear to be cooperating, which after increasing 14% last year appear to be on track (as per our strategist) to increase 7% this year (with average levels up closer to 10%, well above the 7% estimate implied by our models and most company reserve assumptions). Credit conditions continue to track at very favourable levels. Given this backdrop, along with an expected S&P/TSX increase in the mid-single-digit range for 2007, we recently increased our recommendation for the Canadian lifecos from market weight to overweight.
• Reasonable valuations – especially attractive versus other financials. At 13.3x NTM EPS, just marginally over the long-term average multiple of 12.6x, we believe the group is reasonably attractively priced, especially now that the group is down from the over 14x multiple it traded at for a good portion of 2006. Versus other financials – namely, the Canadian banks and the U.S. lifecos – the group looks very attractive. Canadian lifecos currently trade at a 2% premium (forward P/E multiple) to the Canadian banks, in line with their 2% average, and above the 4%-10% levels we’ve seen over the past three years. As well, the expected growth in EPS, heavily in the Canadian lifecos’ favour (15% in 2007, versus 10% for the banks, and 11% in 2008, versus 9% for the banks), adds to the attractiveness of the lifecos. We’ve seen a strong correlation in relative multiple (lifecos/banks) versus the U.S. 10-year treasury yields. As yields increase, the lifecos’ premium to the banks expands, and as yields decline, the premium contracts. Assuming long-term yields do not fall, we do not expect the relative multiple to decline below its current 2% premium. Should long-term yields continue to climb, we would expect the lifeco premium to the banks to expand beyond current levels. Versus U.S. lifecos, the Canadian lifecos look attractive, with a forward P/E multiple spread trading in line with historical average and better EPS growth. The forward P/E multiple for the Canadian lifecos has come down relative to their U.S. counterparts, from a 15% premium a year ago to a 5% premium now, in line with long-term average of 5%. With much better EPS growth, 13% annually through 2008E versus the U.S. lifecos at 8%-9%, we believe the Canadian lifecos look attractive relative to the U.S. lifecos.
• Canadian P&C Insurers – Auto continues to pace ahead of industry norm, commercial becoming increasingly competitive but market remains rational •
• The profitability of Canadian auto insurance continues to pace well ahead of industry norms due to the sustained effectiveness of automobile reforms and continued low frequency levels. We get the impression from management at ING Canada that this trend will continue throughout 2007. The U.S. non-standard auto market (a significant portion of Kingsway’s business) we expect will continue to be much more competitive, but perhaps begin to show signs of more pricing rationality in 2007. We do not anticipate acquisition activity will “heat up” for at least a year, as the exceptional profitability we are currently seeing in the Canadian marketplace could force acquisition prices up in what has tended to be a very cyclical business. Who wants to sell when you’re making profits well above average? When acquisition activity heats up again, likely in 2008, we expect ING Canada, with over $1 billion in excess capital and debt capacity, to be active.
• We continue to be somewhat cautious on commercial lines players at this point in the cycle, largely from a valuation standpoint (we believe Northbridge and Fairfax, at 1.4x and 1.2x respective book values, are approaching full and fair valuations). That said, we believe that while the market will continue to be increasingly competitive, it will likely remain rational, especially if interest rates remain low.
Great-West Lifeco Inc.
1-Sector Outperform – $37 one-year target, based on 3.0x 12/31/07E BV and 13.6x 2008E EPS
• We are looking for $0.56 per share for Q4/06, $0.01 per share above consensus. Our 2007E EPs estimate of $2.46 is $0.06 above consensus.
• With the roll-off of the currency hedge impact, and the accretion from four recent tuck-in acquisitions, we look fro 17% EPS growth in 2007 (14% ex f/x). .
• Any update on Power’s much talked about potential acquisition of Putnam? Likely not, but we believe the company's U.S. 401(k) business could benefit.
• U.S. Health Care (10% of bottom line) should continue to be encouraging, especially with the October 2006 acquisition of Indiana Health Network (75,000 members, a 4% boost in membership).
• European segment (24% of bottom line), up 26% in 2005 and 33% in first nine months of 2006 (ex foreign exchange), should continue to show double-digit growth – with further support in 2007 from the recently announced acquisition.
• Possible 7%-8% dividend increase, in keeping in-line with company's history of a 6%-10% dividend increase every six months.
Industrial-Alliance Insurance and Financial Services Inc.
3-Sector Underperform – $37 one-year target, based on 1.7x 12/31/07E BV and 12.2x 2008E EPS
• We are looking for $0.68 per share in Q4/06, $0.02 per share below consensus. Our 2007 EPS estimate of $2.87 is $0.07 below consensus.
• Low long-term rates and the associated new business strain continue to weigh on the company’s individual insurance segment.
• The Clarington acquisition will continue to propel individual wealth management earnings – but uncertain Canadian equity markets may cause some concern going forward.
Manulife Financial Corporation
2-Sector Perform – $42 one-year target, based on 2.5x 12/31/07E BV and 13.5x 2008E EPS
• We are looking for $0.64 per share for Q4/06, $0.01 per share below consensus. Our 2007 EPS estimate of $2.85 is $0.05 above consensus.
• New Q4/06 product launches – will they translate into a significant lift in growth? We will pay close attention to sales growth in Canadian individual wealth management, U.S. variable annuity and Japan variable annuity, all of which were down significantly YOY in Q3/06.
• A 50% increase in the U.S. Fixed Products segment contributed to MFC’s exceptional 18% growth (24% ex f/x) in the first nine months of 2006 – we don’t expect this trend to continue in 2007.
Sun Life Financial Inc.
1-Sector Outperform – $55 one-year target, based on 1.9x 12/31/07E BV and 12.6x 2008E EPS
• We are looking for $0.93 per share for Q4/06, in line with consensus. Our 2007 EPS estimate of $4.03 is $0.06 above consensus.
• We look for another clean and respectable 12% EPS growth, similar to the 13% we saw in Q3/06.
• U.S. variable annuity – starting to “walk the talk.” For the first time in over two years we saw the company make a significant gain in its market share in Q3/06 (its share was up 10%, making the company the second largest gainer among the top 25 players).
• Media speculation likely resulted in an one-time increase in net redemptions at MFS in Q4/06. We conservatively forecast US$1 billion, versus the US$100 million in Q3/06 and the US$700 in 1H/06.
• Possible 7%-10% dividend increase.
Fairfax Financial Holdings Limited
2-Sector Perform – US$195 one-year target, based on 1.15x 12/31/07E BV
• We expect another steady quarter ($4.67 EPS).
• Runoff segment remains under the radar screen. We expect the run-off to continue to beat its break-even bogey.
• Likelihood of beating estimates is high, given low level of catastrophe and strong equity markets.
ING Canada Inc.
2-Sector Perform – $60 one-year target, based on 2.05x 12/31/07E BV
• We are looking for $0.98 per share for Q4/06, $0.10 per share below consensus. Our 2007 EPS estimate of $4.29 is $0.14 below consensus.
• We forecast a combined ratio of 91%, not as good as the 90% in Q3/06 or the 88% in the first nine months of 2006, but Q4 is typically not as strong as Q2 and Q3.
Kingsway Financial Services Inc.
2-Sector Perform – $29 one-year target, based on 1.4x 9/30/07E BV
• We are looking for $0.77 per share for Q4/06; we believe this is $0.03 above consensus. Our 2007 EPS estimate of $3.04 is $0.04 above consensus.
• We look for a steady quarter in line with consensus, with no significant prior-period reserve development and a combined ratio in the 97% range.
• Recent developments with respect to U.S. non-standard market in Massachusetts, an improved arrangement with Robert Plan, and a declining Canadian dollar might be a catalyst for 2007.
Northbridge Financial Corporation
3-Sector Perform – $35 one-year target, based on 1.4x 12/31/07E BV
• We are looking for $0.87 per share for Q4/06, $0.04 per share above consensus. Our 2007E EPS estimate of $3.03 is $0.21 below consensus.
• We need a couple of steady, clean quarters to re-build investor confidence after significant misses in Q2 and Q3 due to recently exited businesses in the company’s Commonwealth subsidiary. Hopefully, Q4/06 will be the start. We look for a combined ratio of 90%.
;
• Canadian Lifecos – Moving To Overweight •
• Favourable macro environment. The macro environment continues to look good for our insurers. Currency rates are much more favourable than six months ago and continue to move in a direction that adds to our EPS estimates. Long-term interest rates appear to have stabilized, and with Scotia Economics forecasting both U.S. 10-year treasuries and government of Canada 10-year yields to generally remain at current levels through the middle of 2008, we see little in the way of headwinds due to declining long-term yields. U.S. equity markets, where the Canadian lifecos have the majority of their equity market risk, appear to be cooperating, which after increasing 14% last year appear to be on track (as per our strategist) to increase 7% this year (with average levels up closer to 10%, well above the 7% estimate implied by our models and most company reserve assumptions). Credit conditions continue to track at very favourable levels. Given this backdrop, along with an expected S&P/TSX increase in the mid-single-digit range for 2007, we recently increased our recommendation for the Canadian lifecos from market weight to overweight.
• Reasonable valuations – especially attractive versus other financials. At 13.3x NTM EPS, just marginally over the long-term average multiple of 12.6x, we believe the group is reasonably attractively priced, especially now that the group is down from the over 14x multiple it traded at for a good portion of 2006. Versus other financials – namely, the Canadian banks and the U.S. lifecos – the group looks very attractive. Canadian lifecos currently trade at a 2% premium (forward P/E multiple) to the Canadian banks, in line with their 2% average, and above the 4%-10% levels we’ve seen over the past three years. As well, the expected growth in EPS, heavily in the Canadian lifecos’ favour (15% in 2007, versus 10% for the banks, and 11% in 2008, versus 9% for the banks), adds to the attractiveness of the lifecos. We’ve seen a strong correlation in relative multiple (lifecos/banks) versus the U.S. 10-year treasury yields. As yields increase, the lifecos’ premium to the banks expands, and as yields decline, the premium contracts. Assuming long-term yields do not fall, we do not expect the relative multiple to decline below its current 2% premium. Should long-term yields continue to climb, we would expect the lifeco premium to the banks to expand beyond current levels. Versus U.S. lifecos, the Canadian lifecos look attractive, with a forward P/E multiple spread trading in line with historical average and better EPS growth. The forward P/E multiple for the Canadian lifecos has come down relative to their U.S. counterparts, from a 15% premium a year ago to a 5% premium now, in line with long-term average of 5%. With much better EPS growth, 13% annually through 2008E versus the U.S. lifecos at 8%-9%, we believe the Canadian lifecos look attractive relative to the U.S. lifecos.
• Canadian P&C Insurers – Auto continues to pace ahead of industry norm, commercial becoming increasingly competitive but market remains rational •
• The profitability of Canadian auto insurance continues to pace well ahead of industry norms due to the sustained effectiveness of automobile reforms and continued low frequency levels. We get the impression from management at ING Canada that this trend will continue throughout 2007. The U.S. non-standard auto market (a significant portion of Kingsway’s business) we expect will continue to be much more competitive, but perhaps begin to show signs of more pricing rationality in 2007. We do not anticipate acquisition activity will “heat up” for at least a year, as the exceptional profitability we are currently seeing in the Canadian marketplace could force acquisition prices up in what has tended to be a very cyclical business. Who wants to sell when you’re making profits well above average? When acquisition activity heats up again, likely in 2008, we expect ING Canada, with over $1 billion in excess capital and debt capacity, to be active.
• We continue to be somewhat cautious on commercial lines players at this point in the cycle, largely from a valuation standpoint (we believe Northbridge and Fairfax, at 1.4x and 1.2x respective book values, are approaching full and fair valuations). That said, we believe that while the market will continue to be increasingly competitive, it will likely remain rational, especially if interest rates remain low.
Great-West Lifeco Inc.
1-Sector Outperform – $37 one-year target, based on 3.0x 12/31/07E BV and 13.6x 2008E EPS
• We are looking for $0.56 per share for Q4/06, $0.01 per share above consensus. Our 2007E EPs estimate of $2.46 is $0.06 above consensus.
• With the roll-off of the currency hedge impact, and the accretion from four recent tuck-in acquisitions, we look fro 17% EPS growth in 2007 (14% ex f/x). .
• Any update on Power’s much talked about potential acquisition of Putnam? Likely not, but we believe the company's U.S. 401(k) business could benefit.
• U.S. Health Care (10% of bottom line) should continue to be encouraging, especially with the October 2006 acquisition of Indiana Health Network (75,000 members, a 4% boost in membership).
• European segment (24% of bottom line), up 26% in 2005 and 33% in first nine months of 2006 (ex foreign exchange), should continue to show double-digit growth – with further support in 2007 from the recently announced acquisition.
• Possible 7%-8% dividend increase, in keeping in-line with company's history of a 6%-10% dividend increase every six months.
Industrial-Alliance Insurance and Financial Services Inc.
3-Sector Underperform – $37 one-year target, based on 1.7x 12/31/07E BV and 12.2x 2008E EPS
• We are looking for $0.68 per share in Q4/06, $0.02 per share below consensus. Our 2007 EPS estimate of $2.87 is $0.07 below consensus.
• Low long-term rates and the associated new business strain continue to weigh on the company’s individual insurance segment.
• The Clarington acquisition will continue to propel individual wealth management earnings – but uncertain Canadian equity markets may cause some concern going forward.
Manulife Financial Corporation
2-Sector Perform – $42 one-year target, based on 2.5x 12/31/07E BV and 13.5x 2008E EPS
• We are looking for $0.64 per share for Q4/06, $0.01 per share below consensus. Our 2007 EPS estimate of $2.85 is $0.05 above consensus.
• New Q4/06 product launches – will they translate into a significant lift in growth? We will pay close attention to sales growth in Canadian individual wealth management, U.S. variable annuity and Japan variable annuity, all of which were down significantly YOY in Q3/06.
• A 50% increase in the U.S. Fixed Products segment contributed to MFC’s exceptional 18% growth (24% ex f/x) in the first nine months of 2006 – we don’t expect this trend to continue in 2007.
Sun Life Financial Inc.
1-Sector Outperform – $55 one-year target, based on 1.9x 12/31/07E BV and 12.6x 2008E EPS
• We are looking for $0.93 per share for Q4/06, in line with consensus. Our 2007 EPS estimate of $4.03 is $0.06 above consensus.
• We look for another clean and respectable 12% EPS growth, similar to the 13% we saw in Q3/06.
• U.S. variable annuity – starting to “walk the talk.” For the first time in over two years we saw the company make a significant gain in its market share in Q3/06 (its share was up 10%, making the company the second largest gainer among the top 25 players).
• Media speculation likely resulted in an one-time increase in net redemptions at MFS in Q4/06. We conservatively forecast US$1 billion, versus the US$100 million in Q3/06 and the US$700 in 1H/06.
• Possible 7%-10% dividend increase.
Fairfax Financial Holdings Limited
2-Sector Perform – US$195 one-year target, based on 1.15x 12/31/07E BV
• We expect another steady quarter ($4.67 EPS).
• Runoff segment remains under the radar screen. We expect the run-off to continue to beat its break-even bogey.
• Likelihood of beating estimates is high, given low level of catastrophe and strong equity markets.
ING Canada Inc.
2-Sector Perform – $60 one-year target, based on 2.05x 12/31/07E BV
• We are looking for $0.98 per share for Q4/06, $0.10 per share below consensus. Our 2007 EPS estimate of $4.29 is $0.14 below consensus.
• We forecast a combined ratio of 91%, not as good as the 90% in Q3/06 or the 88% in the first nine months of 2006, but Q4 is typically not as strong as Q2 and Q3.
Kingsway Financial Services Inc.
2-Sector Perform – $29 one-year target, based on 1.4x 9/30/07E BV
• We are looking for $0.77 per share for Q4/06; we believe this is $0.03 above consensus. Our 2007 EPS estimate of $3.04 is $0.04 above consensus.
• We look for a steady quarter in line with consensus, with no significant prior-period reserve development and a combined ratio in the 97% range.
• Recent developments with respect to U.S. non-standard market in Massachusetts, an improved arrangement with Robert Plan, and a declining Canadian dollar might be a catalyst for 2007.
Northbridge Financial Corporation
3-Sector Perform – $35 one-year target, based on 1.4x 12/31/07E BV
• We are looking for $0.87 per share for Q4/06, $0.04 per share above consensus. Our 2007E EPS estimate of $3.03 is $0.21 below consensus.
• We need a couple of steady, clean quarters to re-build investor confidence after significant misses in Q2 and Q3 due to recently exited businesses in the company’s Commonwealth subsidiary. Hopefully, Q4/06 will be the start. We look for a combined ratio of 90%.
