Manulife Financial Corporation (MFC, Financial) is the largest Canadian life insurer by market capitalization, offering asset management, wealth management and financial services to customers in Asia, Canada and the U.S. However, the company’s annuity and segregated fund business has suffered over the past two years, due to the low interest rate environment, leading to a decline in earnings and operating results. Nonetheless, the firm has been undergoing some changes throughout 2013 and management expects profitability to increase for fiscal 2014, despite its underperformance during fourth quarter fiscal 2013. Thus, many investment gurus like George Soros (Trades, Portfolio) and Jim Simons' (Trades, Portfolio) hedge fund remain bullish about Manulife’s future outlook, evidenced by their shares purchased in the past quarter.
Of Hedging and Repricing
Manulife’s capital sensitivity and volatile earnings have made it difficult for the company to maintain steady growth prospects in the past, but quarter four's earnings report showed improvements in some aspects, especially regarding EPS growth, which jumped 73% year over year, closing at $1.62 per share. This is largely due to the company’s recent strategy of hedging two-thirds of its variable annuity business, and looking forward all newly written businesses in this segment will be hedged. Furthermore, the firm has been gradually trading most of its short-term bonds for long-term bonds, which will improve the bond duration of its investment portfolio, thereby reducing earning sensitivity. While insurance sales were weak for 2013, declining 13% from 2012 and 32% year over year for the quarter, Manulife’s shift towards expanding its wealth management business (wealth sales increased 37% over the past fiscal year) and mutual fund sales should help offset declines in the future.
In fact, today the company announced that it will be launching a new universal life product for the Canadian market called Manulife UL by May 26 of this year. The new product will offer cost-effective insurance protection, as well as the opportunity for tax-advantaged investing, catering to customer’s demands for a more simplified insurance solution, which should help boost sales to some extent. Although the firm’s balance sheet is highly leveraged, exposing it to possible damages in the case of higher-than-expected policy liabilities, Manulife’s capital position has improved substantially over the past year. With a ratio of regulatory capital to capital required at 248%, the firm possesses excessive capital levels, well above competitors like Prudential Public Limited Company (ADR) (PUK, Financial), China Life Insurance Company Ltd. (ADR) (LFC, Financial), and Sun Life Financial Inc. (USA) (SLF, Financial), which all sport a 200% ratio. Moreover, the company’s excessive capital should allow it to maintain the above average dividend yield of 2.66% offered to shareholders.
Valuation
Over the next five years growth in the Asian market will likely boost the overall modest premium growth rate, averaging it at 2%, while the total revenue CAGR recovers to 3% after the steep declines reported since 2012. Furthermore, Manulife’s ROE will continue its current upward trend, increasing from 2013’s 10.9% to an average 12% by 2018, accompanied by the steadily expanding net margins of 16.8%. While it will take some time for the company’s growth to accelerate, I feel bullish about management’s optimism regarding its business shift, and see the dividend yield and returns on equity as solid benefits for a long term investment. Moreover, the firm is currently trading at a 10% price discount relative to the industry average of 14.0x, making it a relatively inexpensive buy.
Disclosure: Patricio Kehoe holds no position in any stocks mentioned.
