RBC Capital Markets, 11 October 2007
The insurers report Q3/07 results between October 30th and November 8th. Macro environment mixed for lifecos in Q3/07
• North American and Japanese equity markets were up on a year-over-year basis, which benefits all lifecos, but Great-West least so. Japanese equity markets were down sequentially, which may have a negative impact on Manulife's Japanese variable annuity reserves.
• We expect currency translation to negatively impact the big 3 lifecos' earnings growth by 2% on average with Manulife being the most impacted (3% to 4%). The Canadian dollar strengthened against the US Dollar (+6.2%) and the Japanese Yen (+9.1%), but weakened against the Euro (-0.9%) and the British Pound (-1.5%) on a year-over-year basis. Similar to Q2/07, we expect currency translation to have a negative impact on book value growth in Q3/07. Industrial Alliance is not impacted by currency translation.
• There were no major credit losses we are aware of, which benefits Manulife and Sun Life the most since they have more exposure to lower quality classes of bonds.
• Canadian long-term interest rates were up QoQ and YoY on average (though end of period rates at Q3 had declined vs Q2), while US and Japanese rates were down sequentially and on a year-over-year basis on average. Lower long-term interest rates negatively impact all lifecos, but Industrial Alliance and Manulife most so. If Canadian interest rates remain at current levels, they should have a positive impact on H2/07 earnings, though lower rates in the US and Japan may offset any positive benefit that Manulife would get from higher interest rates in Canada.
We expect Great-West to lead the group with EPS growth of 19%. We believe that main drivers for YoY growth at Great-West are: (i) increased profitability from European operations; (ii) earnings contributions from 401(k) acquisitions made in H2/06 and decreased integration expenses related to those acquisitions; and (iii) earnings contributions from the Putnam acquisition which closed on August 3rd.
Sun Life (October 30)
• We expect Q3/07E core EPS of $0.98, below consensus of $1.00. Our EPS estimate represents growth of 5% versus Q3/06 and 2% sequentially.
• Positive variable annuity flows in Q3/07 would provide additional confidence to investors that wholesaler productivity improvements experienced in Q2/07 are sustainable. New products such as Sun Life’s SunDex Bonus Fixed annuity, which was launched at the end of July 2007, may have a positive impact on annuity flows in the quarter. Improving performance in the annuities division is important as it accounted for 75% of US earnings in 2006 (including fixed annuities and equity indexed annuities).
• The growth rate of the non-MFS related Value of New Business for the 12 months ending June 30, 2007 lagged the growth in individual insurance and health sales, which implies a change in product mix or a deterioration in margins. Price increases implemented in Q1/07 for US individual insurance may have a positive impact on margins in Q3/07.
• Sun Life is expected to recapture a large portion of the strain recognized in Q4/06 and Q1/07 in H2/07 due to the implementation of a funding structure in June 2007. We estimate that the recapture of strain may benefit H2/07 earnings by $80-$120 million (pre-tax).
• We expect currency fluctuations to negatively impact earnings by approximately 2% this quarter versus Q3/06 due to the Canadian dollar appreciating by 6.2% YoY versus the US dollar. Partially offsetting this would be the appreciation of the Pound (+1.5% YoY) versus the Canadian dollar. US operations account for 33% of total earnings and U.K. operations account for approximately 8% of total earnings.
• We expect currency translation to negatively impact Q3/07E book value per share by $1.09.
Great-West Life (October 31)
• We expect Q3/07E operating EPS of $0.63 above consensus of $0.61. Our EPS estimate represents growth of 19% versus Q3/06 and 3% sequentially.
• Great-West closed the Putnam transaction on August 3rd. We are expecting Putnam to contribute $24 million in net income or $0.03 in Q3/07.
• US financial services should benefit from favourable comparables due to (i) poor morbidity experience in Q3/06 that impacted earnings by approximately US$12 million and (ii) 401(k) related acquisitions made in H2/06. Management indicated Q3/07 should be the last quarter of integration expenses (US$5 million) related to the acquisition of the US Bank business.
• We expect the European division to continue to positively surprise investors, based on:
• the strengthening British pound against the Canadian dollar;
• life reinsurance operations that are in a position to gain market share from the larger players, as primary insurers look to diversify their counterparty exposures; and
• the shift of acquired investment portfolios that back payout annuities toward higher yielding securities.
• We expect currency translation to negatively impact Q3/07E earnings by approximately 1% to 2% this quarter versus Q3/06. Great-West’s US and Reinsurance earnings should be negatively impacted due to the strengthening of the Canadian dollar versus the US dollar (up 6.2% YoY). Partially offsetting this is our expectation of positive earnings translations from Great West’s European operations due to the strengthening of the Euro (up 0.9% YoY) and the British Pound (up 1.5% YoY) versus the Canadian dollar. US operations (including Reinsurance and excluding Putnam) account for approximately 32% earnings, while European operations account for approximately 18% of earnings.
• We expect currency translation to negatively impact Q3/07E book value per share by $0.50.
Manulife (November 6)
• We expect Q3/07E core EPS of $0.70, slightly below consensus of $0.71. Our EPS estimate represents growth of 10% versus Q2/06 and (1)% sequentially.
• We believe that Q3/07 Japanese variable annuity sales results may top Manulife's previous best quarter of US$1.05 billion (Q1/06). Manulife's shares should react positively to an improvement in Japanese variable annuity sales as sales had declined to approximately US$400 million per quarter since July 2006, when a key product was shelved for regulatory reasons.
• We are expecting a sizeable year-over-year increase in the Value of New Business (VNB) driven primarily by (i) improved variable annuity sales results in Japan; (ii) our expectation that insurance sales will continue to be strong following a 15% increase in sales in Q2/07 compared to Q2/06 and (iii) an easy comparable due to Manulife’s Q3/06 VNB of $384 million that was negatively impacted by the shelving of a key variable annuity product in Japan.
• Positive equity market returns and good credit conditions should benefit Manulife’s earnings from (i) surplus (ii) variable annuities in the US and Japan and (iii) its John Hancock Fixed Investment division.
• The strengthening Canadian dollar versus the US dollar (up 6.2% YoY) and the Japanese Yen (up 9.1% YoY) should translate into an earnings drag of approximately 3% to 4% compared to Q3/06 for Manulife. Manulife’s US operations account for 45% of earnings and its Japanese operations account for 8%.
• We expect currency translation to negatively impact Q3/07E book value per share by $0.89.
Industrial Alliance (November 7)
• We expect Q3/07E core EPS of $0.78, above consensus of $0.77. Our EPS estimate represents growth of 13% YoY versus Q3/06 and 1% sequentially.
• At a recent presentation, management indicated that individual insurance sales would increase in H2/07 versus H2/06 while strain from individual insurance sales would decrease in line with its guidance of 50% to 55%. If Industrial Alliance delivers these results, we believe its shares would react positively.
• In August, IAG reported it had approximately $200 million of non-bank issued asset backed commercial paper (ABCP) and that it transferred approximately 50% of its exposure to its general fund in order to protect investors invested in money market funds from any potential losses. We expect IAG to provide an update on any write-downs related to its ABCP when it reports its earnings.
Power Corporation (November 8)
• We expect Power Corporation to report Q3/07E EPS of $0.69, up 19% versus Q3/06. The increase in earnings is a result of our expectation that Power Financial’s Q3/07 earnings will increase 19% year over year (see below). Power Financial represents approximately 100% of Power Corporation’s Q3/07 estimated EPS since the remaining component “Other Assets” is expected to have a negative contribution to earnings in Q3/07.
Power Financial (November 8)
• We expect Great-West to report Q3/07E EPS of $0.63, up 19% versus Q3/06. The expected increase in Great-West’s earnings is driven by: (i) integration of announced acquisitions including Putnam; (ii) continued strong growth in Europe; and (iii) potential improvements in US healthcare. Great-West represents 75% of Power Financial’s Q3/07 estimated EPS.
• We expect IGM Financial to report Q3/07 EPS of $0.81, up 13% versus Q3/06. IGM Financial represents 23% of Power Financial’s Q3/07 estimated EPS.
• We expect Pargesa to report an increase in core earnings of approximately 40% in Q3/07 versus Q3/06. The expected increase in Pargesa’s earnings is driven by: (i) increased ownership in Lafarge, Pernod Ricard and Suez; and (ii) increased dividend payments at Total, Suez, and Lafarge. Pargesa represents 3% of Power Financial’s Q3/07 estimated EPS
Valuation
IAG Our 12-month price target of $45 is a combination of our P/E, price to book and embedded value methodologies. It implies an approximate forward multiple of 13.0x earnings, compared to the 5-year average forward multiple of 11.8x. Our P/B target of 2.1x in 12 months is at the low end of our target for lifecos given a lower expected ROE. Our target P/E multiple of 13.0x 2008E earnings is higher than the company’s 5-year average forward P/E, as we believe Industrial Alliance is well positioned to benefit from higher interest rates, has increased its geographic diversification and has limited exposure to deteriorating credit quality. Offsetting those positives are uncertain equity markets and increased competition in the Canadian individual insurance market. Our target multiple on embedded value of 1.4x is lower than for the other two domestic lifecos, reflecting the mature nature of the Canadian insurance industry.
GWO: Our 12-month price target of $40 is a combination of our P/E and price to book methodologies. It implies an approximate forward multiple of 13.9x earnings, compared to the 5-year average forward multiple of 13.4x. Our P/B target of 3.1x in 12 months is at the high end of our target for lifecos given a higher expected ROE than average. Our target P/E multiple of 13.5x 2008E earnings is in line with the company’s 5-year average forward P/E to reflect potential benefits from recent acquisitions, a more accommodating currency and limited exposure to deteriorating credit quality. Offsetting those positives are uncertain equity markets and increased pressure on US healthcare earnings.
MFC: Our 12-month price target of $47 is a combination of our P/E, price to book and embedded value methodologies. It implies an approximate forward multiple of 14.5x earnings, compared to the 5-year average forward multiple of 13.1x. Our P/B target of 2.9x in 12 months is at the high end of our target for lifecos given a higher expected ROE than average. Our target P/E multiple of 14.5x 2008E earnings is above the company's 5-year average forward P/E to reflect potential benefits from higher interest rates, rapidly growing value of new business, and potential for upward EPS revisions as our expected earnings growth is below what the company has historically achieved and is targeting, partially offset by deteriorating credit quality, uncertain equity market performance and lack of benefits from transformational acquisitions. Our target multiple on embedded value of 2.0x is higher than for the other two Canadian lifecos, reflecting higher prospects for growth in value of new business, because of the company's positioning in Asia and the US
SLF: Our 12-month price target of $57 is a combination of our P/E, price to book and embedded value methodologies. It implies an approximate forward multiple of 12.5x earnings, compared to the 5-year average forward multiple of 12.1x. Our P/B target of 2.1x in 12 months is at the low end of our target for lifecos given a lower expected ROE. Our target P/E multiple of 13.0x 2008E earnings is above the company's 5-year average forward P/E to reflect potential benefits from higher interest rates, partially offset by deteriorating credit quality, uncertain equity market performance and lack of benefits from transformational acquisitions. Our target multiple on embedded value of 1.6x reflects the mature nature of the Canadian insurance industry and superior growth prospects in Asia.
POW: Our 12-month target price of $43 is based on a 12-month target NAV of $50 target price and a discount to NAV of 15% which is the mid-point of the average discount to NAV over the past 17 years (14%) and the past 5 years (16%). The current discount to NAV is 14%. Our target NAV is based on a $45 price target for Power Financial.
PWF: Our 12-month target price of $45 is based on a target NAV of $49 and a discount to NAV of 9% which is slightly above the trailing 5-year average of 8% and below the trailing 16-year average of 13%. Our target NAV is based on (1) a target price of $40 for Great-West which implies an approximate forward multiple of 13.9x earnings, compared to the 5-year average forward multiple of 13.4x (2) a target price of $59 for IGM Financial which is based on a sum-of-the-parts NAV approach. We separately value: the mutual fund business; the non-mutual fund business; and IGM's 4.2% stake in Great-West Life.; (3) a price of C$113.13 for Pargesa which is in line with the current stock price.
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The insurers report Q3/07 results between October 30th and November 8th. Macro environment mixed for lifecos in Q3/07
• North American and Japanese equity markets were up on a year-over-year basis, which benefits all lifecos, but Great-West least so. Japanese equity markets were down sequentially, which may have a negative impact on Manulife's Japanese variable annuity reserves.
• We expect currency translation to negatively impact the big 3 lifecos' earnings growth by 2% on average with Manulife being the most impacted (3% to 4%). The Canadian dollar strengthened against the US Dollar (+6.2%) and the Japanese Yen (+9.1%), but weakened against the Euro (-0.9%) and the British Pound (-1.5%) on a year-over-year basis. Similar to Q2/07, we expect currency translation to have a negative impact on book value growth in Q3/07. Industrial Alliance is not impacted by currency translation.
• There were no major credit losses we are aware of, which benefits Manulife and Sun Life the most since they have more exposure to lower quality classes of bonds.
• Canadian long-term interest rates were up QoQ and YoY on average (though end of period rates at Q3 had declined vs Q2), while US and Japanese rates were down sequentially and on a year-over-year basis on average. Lower long-term interest rates negatively impact all lifecos, but Industrial Alliance and Manulife most so. If Canadian interest rates remain at current levels, they should have a positive impact on H2/07 earnings, though lower rates in the US and Japan may offset any positive benefit that Manulife would get from higher interest rates in Canada.
We expect Great-West to lead the group with EPS growth of 19%. We believe that main drivers for YoY growth at Great-West are: (i) increased profitability from European operations; (ii) earnings contributions from 401(k) acquisitions made in H2/06 and decreased integration expenses related to those acquisitions; and (iii) earnings contributions from the Putnam acquisition which closed on August 3rd.
Sun Life (October 30)
• We expect Q3/07E core EPS of $0.98, below consensus of $1.00. Our EPS estimate represents growth of 5% versus Q3/06 and 2% sequentially.
• Positive variable annuity flows in Q3/07 would provide additional confidence to investors that wholesaler productivity improvements experienced in Q2/07 are sustainable. New products such as Sun Life’s SunDex Bonus Fixed annuity, which was launched at the end of July 2007, may have a positive impact on annuity flows in the quarter. Improving performance in the annuities division is important as it accounted for 75% of US earnings in 2006 (including fixed annuities and equity indexed annuities).
• The growth rate of the non-MFS related Value of New Business for the 12 months ending June 30, 2007 lagged the growth in individual insurance and health sales, which implies a change in product mix or a deterioration in margins. Price increases implemented in Q1/07 for US individual insurance may have a positive impact on margins in Q3/07.
• Sun Life is expected to recapture a large portion of the strain recognized in Q4/06 and Q1/07 in H2/07 due to the implementation of a funding structure in June 2007. We estimate that the recapture of strain may benefit H2/07 earnings by $80-$120 million (pre-tax).
• We expect currency fluctuations to negatively impact earnings by approximately 2% this quarter versus Q3/06 due to the Canadian dollar appreciating by 6.2% YoY versus the US dollar. Partially offsetting this would be the appreciation of the Pound (+1.5% YoY) versus the Canadian dollar. US operations account for 33% of total earnings and U.K. operations account for approximately 8% of total earnings.
• We expect currency translation to negatively impact Q3/07E book value per share by $1.09.
Great-West Life (October 31)
• We expect Q3/07E operating EPS of $0.63 above consensus of $0.61. Our EPS estimate represents growth of 19% versus Q3/06 and 3% sequentially.
• Great-West closed the Putnam transaction on August 3rd. We are expecting Putnam to contribute $24 million in net income or $0.03 in Q3/07.
• US financial services should benefit from favourable comparables due to (i) poor morbidity experience in Q3/06 that impacted earnings by approximately US$12 million and (ii) 401(k) related acquisitions made in H2/06. Management indicated Q3/07 should be the last quarter of integration expenses (US$5 million) related to the acquisition of the US Bank business.
• We expect the European division to continue to positively surprise investors, based on:
• the strengthening British pound against the Canadian dollar;
• life reinsurance operations that are in a position to gain market share from the larger players, as primary insurers look to diversify their counterparty exposures; and
• the shift of acquired investment portfolios that back payout annuities toward higher yielding securities.
• We expect currency translation to negatively impact Q3/07E earnings by approximately 1% to 2% this quarter versus Q3/06. Great-West’s US and Reinsurance earnings should be negatively impacted due to the strengthening of the Canadian dollar versus the US dollar (up 6.2% YoY). Partially offsetting this is our expectation of positive earnings translations from Great West’s European operations due to the strengthening of the Euro (up 0.9% YoY) and the British Pound (up 1.5% YoY) versus the Canadian dollar. US operations (including Reinsurance and excluding Putnam) account for approximately 32% earnings, while European operations account for approximately 18% of earnings.
• We expect currency translation to negatively impact Q3/07E book value per share by $0.50.
Manulife (November 6)
• We expect Q3/07E core EPS of $0.70, slightly below consensus of $0.71. Our EPS estimate represents growth of 10% versus Q2/06 and (1)% sequentially.
• We believe that Q3/07 Japanese variable annuity sales results may top Manulife's previous best quarter of US$1.05 billion (Q1/06). Manulife's shares should react positively to an improvement in Japanese variable annuity sales as sales had declined to approximately US$400 million per quarter since July 2006, when a key product was shelved for regulatory reasons.
• We are expecting a sizeable year-over-year increase in the Value of New Business (VNB) driven primarily by (i) improved variable annuity sales results in Japan; (ii) our expectation that insurance sales will continue to be strong following a 15% increase in sales in Q2/07 compared to Q2/06 and (iii) an easy comparable due to Manulife’s Q3/06 VNB of $384 million that was negatively impacted by the shelving of a key variable annuity product in Japan.
• Positive equity market returns and good credit conditions should benefit Manulife’s earnings from (i) surplus (ii) variable annuities in the US and Japan and (iii) its John Hancock Fixed Investment division.
• The strengthening Canadian dollar versus the US dollar (up 6.2% YoY) and the Japanese Yen (up 9.1% YoY) should translate into an earnings drag of approximately 3% to 4% compared to Q3/06 for Manulife. Manulife’s US operations account for 45% of earnings and its Japanese operations account for 8%.
• We expect currency translation to negatively impact Q3/07E book value per share by $0.89.
Industrial Alliance (November 7)
• We expect Q3/07E core EPS of $0.78, above consensus of $0.77. Our EPS estimate represents growth of 13% YoY versus Q3/06 and 1% sequentially.
• At a recent presentation, management indicated that individual insurance sales would increase in H2/07 versus H2/06 while strain from individual insurance sales would decrease in line with its guidance of 50% to 55%. If Industrial Alliance delivers these results, we believe its shares would react positively.
• In August, IAG reported it had approximately $200 million of non-bank issued asset backed commercial paper (ABCP) and that it transferred approximately 50% of its exposure to its general fund in order to protect investors invested in money market funds from any potential losses. We expect IAG to provide an update on any write-downs related to its ABCP when it reports its earnings.
Power Corporation (November 8)
• We expect Power Corporation to report Q3/07E EPS of $0.69, up 19% versus Q3/06. The increase in earnings is a result of our expectation that Power Financial’s Q3/07 earnings will increase 19% year over year (see below). Power Financial represents approximately 100% of Power Corporation’s Q3/07 estimated EPS since the remaining component “Other Assets” is expected to have a negative contribution to earnings in Q3/07.
Power Financial (November 8)
• We expect Great-West to report Q3/07E EPS of $0.63, up 19% versus Q3/06. The expected increase in Great-West’s earnings is driven by: (i) integration of announced acquisitions including Putnam; (ii) continued strong growth in Europe; and (iii) potential improvements in US healthcare. Great-West represents 75% of Power Financial’s Q3/07 estimated EPS.
• We expect IGM Financial to report Q3/07 EPS of $0.81, up 13% versus Q3/06. IGM Financial represents 23% of Power Financial’s Q3/07 estimated EPS.
• We expect Pargesa to report an increase in core earnings of approximately 40% in Q3/07 versus Q3/06. The expected increase in Pargesa’s earnings is driven by: (i) increased ownership in Lafarge, Pernod Ricard and Suez; and (ii) increased dividend payments at Total, Suez, and Lafarge. Pargesa represents 3% of Power Financial’s Q3/07 estimated EPS
Valuation
IAG Our 12-month price target of $45 is a combination of our P/E, price to book and embedded value methodologies. It implies an approximate forward multiple of 13.0x earnings, compared to the 5-year average forward multiple of 11.8x. Our P/B target of 2.1x in 12 months is at the low end of our target for lifecos given a lower expected ROE. Our target P/E multiple of 13.0x 2008E earnings is higher than the company’s 5-year average forward P/E, as we believe Industrial Alliance is well positioned to benefit from higher interest rates, has increased its geographic diversification and has limited exposure to deteriorating credit quality. Offsetting those positives are uncertain equity markets and increased competition in the Canadian individual insurance market. Our target multiple on embedded value of 1.4x is lower than for the other two domestic lifecos, reflecting the mature nature of the Canadian insurance industry.
GWO: Our 12-month price target of $40 is a combination of our P/E and price to book methodologies. It implies an approximate forward multiple of 13.9x earnings, compared to the 5-year average forward multiple of 13.4x. Our P/B target of 3.1x in 12 months is at the high end of our target for lifecos given a higher expected ROE than average. Our target P/E multiple of 13.5x 2008E earnings is in line with the company’s 5-year average forward P/E to reflect potential benefits from recent acquisitions, a more accommodating currency and limited exposure to deteriorating credit quality. Offsetting those positives are uncertain equity markets and increased pressure on US healthcare earnings.
MFC: Our 12-month price target of $47 is a combination of our P/E, price to book and embedded value methodologies. It implies an approximate forward multiple of 14.5x earnings, compared to the 5-year average forward multiple of 13.1x. Our P/B target of 2.9x in 12 months is at the high end of our target for lifecos given a higher expected ROE than average. Our target P/E multiple of 14.5x 2008E earnings is above the company's 5-year average forward P/E to reflect potential benefits from higher interest rates, rapidly growing value of new business, and potential for upward EPS revisions as our expected earnings growth is below what the company has historically achieved and is targeting, partially offset by deteriorating credit quality, uncertain equity market performance and lack of benefits from transformational acquisitions. Our target multiple on embedded value of 2.0x is higher than for the other two Canadian lifecos, reflecting higher prospects for growth in value of new business, because of the company's positioning in Asia and the US
SLF: Our 12-month price target of $57 is a combination of our P/E, price to book and embedded value methodologies. It implies an approximate forward multiple of 12.5x earnings, compared to the 5-year average forward multiple of 12.1x. Our P/B target of 2.1x in 12 months is at the low end of our target for lifecos given a lower expected ROE. Our target P/E multiple of 13.0x 2008E earnings is above the company's 5-year average forward P/E to reflect potential benefits from higher interest rates, partially offset by deteriorating credit quality, uncertain equity market performance and lack of benefits from transformational acquisitions. Our target multiple on embedded value of 1.6x reflects the mature nature of the Canadian insurance industry and superior growth prospects in Asia.
POW: Our 12-month target price of $43 is based on a 12-month target NAV of $50 target price and a discount to NAV of 15% which is the mid-point of the average discount to NAV over the past 17 years (14%) and the past 5 years (16%). The current discount to NAV is 14%. Our target NAV is based on a $45 price target for Power Financial.
PWF: Our 12-month target price of $45 is based on a target NAV of $49 and a discount to NAV of 9% which is slightly above the trailing 5-year average of 8% and below the trailing 16-year average of 13%. Our target NAV is based on (1) a target price of $40 for Great-West which implies an approximate forward multiple of 13.9x earnings, compared to the 5-year average forward multiple of 13.4x (2) a target price of $59 for IGM Financial which is based on a sum-of-the-parts NAV approach. We separately value: the mutual fund business; the non-mutual fund business; and IGM's 4.2% stake in Great-West Life.; (3) a price of C$113.13 for Pargesa which is in line with the current stock price.
