Friday, August 07, 2009

Manulife Q2 2009 Earnings

  
Scotia Capital, 7 August 2009

Event

• MFC reported $1.09 EPS, versus our $0.45 estimate and consensus of $0.70. Dividend was cut 50% as part of MFC's plan to build "fortress" capital levels.

Implications

• 50% dividend cut was very disappointing - it's now up to MFC to prove it can service this capital better and that a reduced dividend is a better long-term value proposition. At least the dividend cut was done from a position of strength - MCCSR at 242% (likely 255% based on current markets, highest we've ever seen it) - and in no way suggests the company is in difficulty.

• We peg Q2/09 underlying EPS in the $0.48 range (lower than our $0.52 estimate), which would correspond to a 12% ROE for the quarter - credit risk profile remains excellent. Sales were weak over a strong Q2/08.

• We're lowering our 2010 EPS estimate to $2.35 from $2.58.

Recommendation

• With the dividend cut and weaker sales, MFC is becoming a show me story, but at 9.5x 2010E EPS there's excellent valuation support for what we believe is still a very strong global franchise.

Dividend Cut Was Disappointing

• 50% dividend cut was very disappointing - it's now up to MFC to prove it can service this capital better and that a reduced dividend is a better long term value proposition. Claiming to want to build "fortress" capital levels from a position of strength, the dividend was cut. And while talked about as being essentially last on the list of potential means of fortifying MFC's already high capital levels (outside of an equity raise), actually going ahead with it was unexpected and disappointing.

• At least the dividend cut was done from a position of strength - MCCSR at 242% (likely 255% based on current markets, highest we've ever seen it) - and in no way suggests company is in difficulty. This dividend cut was in no way a sign of weakness, and, if the objective is to build capital to record levels to provide a cushion larger than we've ever seen to protect from downside risk and support growth of what is likely now more capital intensive products, then certainly a dividend cut is the most cost effective means of achieving this objective. We estimate the current MCCSR (255% as of today's markets) can withstand a 27% decline in equity markets before the ratio hits 200%. The dividend cut adds 10 points annually to the MCCSR.

• We peg Q2/09 underlying EPS in the $0.48 range (lower than our $0.52 estimate), which would correspond to a 12% ROE for the quarter - credit risk profile remains excellent. Exhibit 1 details the development. MFC's credit risk profile remains impressive. With just $0.13 EPS in credit hits in Q2/09, the company did significantly better than SLF ($0.78 EPS) and GWO ($0.27). Gross unrealized losses on fixed income securities below 80% of amortized cost for more than six months are 2.5% of the bond portfolio, faring much better than SLF (5.8%) and GWO (4.3%).

• We're lowering our 2010 EPS estimate to $2.35 from $2.58, in part to reflect lower-than-expected underlying EPS in the quarter, and in part to reflect management's comments on "normalized earnings" (suggested to be $0.46 to $0.52). The "normalized earnings", which in no way should be construed as guidance, assume 2% market appreciation per quarter and include no experience gains/losses and no assumption changes, which, together have accounted for $0.65 in EPS on average annually since 2004 (largely experience gains over the company's conservative assumptions). We believe it is highly unlikely these will be eliminated in 2010, even a level of 1/2 or 1/4 the $0.65 average is possible, in our opinion. As well, our estimates assume the S&P 500 will end 2010 at 1,150, 10% higher than management's 2% per quarter appreciation from June 30, 2009 levels. 2010E ROE is 13.3%.

• More noise in Q3/09. A Q3/09 review of all assumptions, the most significant change being policyholder lapse as it relates to VA/seg fund guarantees, should result in an estimated charge not to exceed $0.30 EPS. We expect other reserve-related lapse and interest charges (but, because of a different methodology, not nearly to the same extent as SLF's expected $0.90 EPS hit), to result in an additional $0.30 EPS hit.

• Weak sales over a strong Q2/08. U.S. VA sales were down 31% as MFC de-risks this portfolio (it believes it is ahead of its peers) and U.S. individual insurance sales down 29% (but progressively improving month over month). Canadian sales were mixed. Asia was strong.
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