Monday, July 16, 2007

Preview of Life Insurance Cos Q2 2007 Earnings

  
Scotia Capital, 16 July 2007

Event

• Canadian insurers start reporting Q2/F07 results on July 31. We've released our detailed Insurance Q2/F07 Earnings Preview on July 16.

What It Means

• We believe the Canadian lifecos could beat our EPS estimates this quarter (which are $0.01 below consensus for each lifeco) despite the currency headwind, largely due to very buoyant equity markets (up 17% YOY).

• Going forward we see little likelihood of EPS increases, in fact there could be decreases, as currency continues to be a headwind and equity markets are expected to appreciate only in the mid-single digit range. Exceptions include SLF, where the recently announced funding arrangement and stronger US VA sales levels could add $0.05-$0.07 to 2H/07 EPS and $0.03 in 2008, and GWO, where Putnam financing without common equity issuance could add $0.05-$0.06 to our 2008 estimate (we currently account for 1/2 of this).

The following is an excerpt and a summary from our Insurance Q2/F07 Earnings Preview report released July 16.

• There is a possibility, due to the buoyant equity markets in Q2/F07, that the companies could beat our estimates and consensus despite the currency headwinds. Certainly, currency has been a headwind. The average CAD continues to be particularly strong. In Q2/F07 it is up 3% year-over-year (YOY) and 7% quarter-over-quarter (QOQ) versus the USD, it is up 9% YOY and QOQ versus the ¥, and it is up 5% QOQ but down 6% YOY versus the £. Manulife in particular suffers, and, with 65% of its earnings exposed to the USD and 10% exposed to the ¥, we estimate that YOY foreign exchange changes could take $0.02 to possibly $0.03 out of Q2/07E EPS (the impact is effectively already in our estimates). For Great-West Lifeco and Sun Life the impact is closer to $0.01 (again, the impact is already in our estimates), as both these companies have less exposure to the USD and more exposure to the £, which in fact outpaced the average Q2/F07 CAD on a YOY basis. But we believe the currency headwind could be more than offset by several positives on a YOY basis, namely favourable equity markets, a continued favourable credit environment, and the positive impact of rising long-term interest rates. U.S. and Canadian equity markets are each up 17% YOY (on average) and 5% and 7% QOQ (on average), respectively, well in excess of the 7% annualized rate we assume. This could translate into better-than-expected fee income from wealth management business, better-than-expected net realized gains on assets supporting surplus, and possibly some favourable movement in reserves associated with guarantees on segregated fund/variable annuity business. We estimate the average EPS impact of these stronger-than-expected markets YOY to be $0.02-$0.03 in Q2/F07 for the lifecos (currently not in our estimates), with Sun Life and Industrial-Alliance, each by a small margin, benefiting the most. This benefit more than offsets the negative headwind due to currency.

• But we see little likelihood of any significant increases in EPS estimates going forward. Unless we see something higher than a 7% return on the equity markets going forward (our portfolio strategist suggests just 2%-3% for the S&P/TSX and 6%-7% for the S&P 500), the 3% expected appreciation in the average CAD versus the USD in 2008 over average Q2/F07 levels (as per the most recent Scotia Economics forecast) will continue to put pressure on EPS estimates, especially for Manulife. The pressure is a little less for Great-West Lifeco and Sun Life due to more exposure to the £ (which, as per the most recent Scotia Economics forecast, is expected to be flat versus the CAD through the end of 2008), and less exposure to the USD. That said, the credit environment remains favourable and rising long-term interest rates certainly help more than hurt.

• However, for SLF and GWO we could see increases in EPS estimates. Sun Life, however, is one company for which we expect there is a chance it will come out of the quarter with a lift in EPS estimates, largely due to the recently announced funding arrangement for its U.S. insurance business, and mostly impacting the second half of 2007. Great-West Lifeco is another, where we believe the strong likelihood of funding the Putnam acquisition without issuing common equity could add another $0.02 to 2008E EPS (in addition to $0.03 we have already incorporated).

Great-West Lifeco Inc.

1-Sector Outperform : $40 target, based on 3.0x 6/30/08E BV & 14.1x 2008E EPS

• We are looking for $0.58 per share for Q2/F07, $0.01 per share below consensus. Our 2007 EPS estimate is $2.41, $0.01 ahead of consensus, and our 2008 EPS estimate is $2.75, $0.04 ahead of consensus.

• We look for the Putnam acquisition to close imminently, and financing to be finalized, with no common equity issuance. We believe that financing without common equity will add another $0.02 to 2008E EPS (in addition to $0.03 we have already incorporated).

• Europe should continue to drive growth, helped in part by $10.9 billion brought in-house in February, 2007, from the Equitable Life payout annuity block acquisition.

• Recently completed tuck-in acquisitions in the United States (two 401(k) blocks and managed care blocks, all closed in the last nine months) should start to bear fruit.

• We look for a 6% increase in the dividend.

Industrial-Alliance Insurance and Financial Services Inc.

3-Sector Underperform : $38 target, based on 1.7x 6/30/08E BV & 12.5x '08E EPS

• We are looking for $0.73 per share in Q2/F07, $0.01 below consensus. Our 2007 EPS estimate of $2.96 is $0.01 below consensus, and our 2008 EPS estimate of $3.19 is $0.09 below consensus.

• A significant reduction in new business strain is likely to drive results in Q2/07 (helped in part by a decline in YOY sales), but strain reduction will unlikely be a growth driver in 2008.

• Unless another acquisition is made, we see 2008 EPS growth returning to the 8%-9% range, consistent with the 8% organic growth in 2006 (ex the tax gains) and the expected 10% organic growth in 2007 (ex the tax gains).

• Good chance of a 7%-11% dividend increase.

Manulife Financial Corporation

2-Sector Perform : $43 target, based on 2.5x 6/30/08E BV and 13.9x 2008E EPS

• We are looking for $0.68 per share for Q2/F07, $0.01 per share below consensus. Our 2007 EPS estimate of $2.75 is in line with consensus and our 2008 EPS estimate of $3.06 is $0.05 below consensus.

• We look for 5% earnings growth in the U.S. division (ex foreign exchange) as the U.S. Fixed Products segment finally starts to return to 'guided to' earnings levels.

• New U.S. variable annuity product launch is expected continue to gain traction, but we expect an update on new product launches slated for Q3/F07 in Japan, as well as measures to address the continued slide in U.S. individual insurance sales.

• Share buyback activity appears to have picked up again. Q2/F07 activity was a twice the run rate of prior three quarters. If current pace continues we could $0.02-$0.03 to 2008E EPS.

• We assume the CAD will average US$0.93 in 2008; if it's US$0.95 we will decrease our EPS estimate by $0.05 per share, and if it's US$0.99 we will decrease our estimate by $0.12.

Sun Life Financial Inc.

1-Sector Outperform : $58 target, based on 1.9x 6/30/08E BV & 13.0x 2008E EPS

• We are looking for $0.95 per share for Q2/F07, $0.01 below consensus. Our 2007 EPS estimate of $3.92 is $0.04 below consensus and our 2008 EPS estimate of $4.41 is line with consensus.

• Good likelihood of raising 2007 EPS estimates by $0.05-$0.07 coming out of this quarter due to recently announced funding arrangement, and $0.03 in 2008 due to strength in U.S VA sales.

• We look for a 5%-8% dividend increase, consistent with the company’s practice of increasing the dividend 5%-9% each six months over the last several years.
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