Friday, August 07, 2009

Sun Life Q2 2009 Earnings

  
Scotia Capital, 7 August 2009

Event

• EPS was $1.05, beating our $0.95 estimate and consensus of $0.89.

Implications

• Credit hits continue to hurt EPS. SLF's track record in this regard has been extremely poor, in our opinion. Total credit hits in Q2/09 were $0.78 EPS, well above our $0.39 estimate.

• A very noisy Q2/09; we'd peg underlying EPS in line with our $0.72 estimate and underlying ROE at 10%. However, since credit hits are consistent and consistently high, we believe the likelihood of achieving this level in the near term is highly unlikely. We're lowering our 2010E EPS to $3.15 from $3.20, but credit remains a wildcard. We're forecasting just $0.18 in credit hits in EPS in 2010, but we remain very sceptical and uneasy.

• U.S. top-line starting to show some positive momentum,with Canada top-line mixed. MFS was strong, but at only 8% of underlying EPS, it's difficult for it to significantly move the needle.

Recommendation

• Positive momentum in U.S. sales is encouraging, but credit continues to be of concern. At 10.5x 2010E EPS, we believe SLF

Credit Woes Continue

• Noisy Q2/09 - but we'd peg underlying EPS in line with our $0.72 estimate. The details are outlined in Exhibit 1. Underlying EPS excludes the impact of credit hits. Since credit hits are consistent and consistently high, we believe the concept of underlying EPS and the likelihood of achieving this level in the near term is highly unlikely.

• Credit hits continue to hurt EPS. SLF's track record in this regard has been extremely poor, in our opinion. Total credit hits in Q2/09 were $0.78 EPS, well above our $0.39 estimate, and significantly higher than GWO's $0.27 and MFC's $0.13. SLF's total credit hits since Q3/08 (ex LEH/Wamu/AIG) have been $2.42 in EPS, well above MFC's $0.56 and GWO's $0.48. Included in the $0.78 in credit hits were $0.17 for CMBS and commercial mortgages, and $0.22 in impairment charges, including $0.12 for CIT.

• We're lowering our 2010E EPS to $3.15 from $3.20, but credit remains a wildcard - we're forecasting just $0.18 in credit hits in EPS in 2010, but we remain very sceptical and uneasy. We outline the details in Exhibit 2. As well, with Sun Life's gross unrealized losses on bonds trading below 80% of amortized cost for more than six months accounting for 5.8% of the company's bond portfolio, more than double that of MFC's (2.5%) and significantly higher than GWO (4.3%), we remain cautious. Our 2010E ROE is 10.4%. We expect the company will provide some form of core EPS potential for 2010 when it presents Q3/09 results.

• Q3/09 could be ugly. The company indicated it could take a $0.80-$0.98 EPS reserve-related hit in Q3/09, as it updates its actuarial methodology and assumptions related to interest rates and equity markets. More specifically, compliance with updated actuarial practice with regards to stochastic economic generators is driving the change. None of the other Canadian lifecos use a stochastic economic generator (they use deterministic), and therefore will not be affected. Combining this hit with likely $0.30 EPS in credit hits (a real wildcard once again) and about $0.25 in possible gains due to rebounding equity markets in Q3/09, we still arrive at an estimated $0.22 EPS loss.

• U.S. top-line starting to show some positive momentum. Sun Life's domestic U.S. variable annuity sales were up 63% YOY, and U.S. core (ex COLI/BOLI/PPVUL) individual insurance sales were up 33%, as company efforts to boost wholesaler productivity (reducing wholesaler count, but poaching some of the industry's best wholesalers from competitors) are beginning to bear fruit. The U.S. operations will embark on a rebranding campaign at the end of the year.

• MFS very strong - but at only 8% of underlying EPS it's difficult for it to significantly move the needle. Gross sales, including managed funds, were up 20% YOY and ex managed funds were up 8% YOY. Net sales were a very strong $4.9B, including retail net flows of $1.2B. While MFS is strong, it still accounts for only 8% of underlying EPS.

• Canada mixed. Ind. insurance sales were down 5% and wealth management sales fell 9%.
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