We are initiating coverage on Canada based Manulife Financial Corp. (MFC) with a Neutral recommendation. During the third quarter, the company posted a net loss of 73 cents per share, narrower than the loss of $1.28 in the prior-year quarter.
Manulife is one of the dominant life insurers within its domestic Canadian market and possesses rapidly growing operations in the U.S. and several Asian countries.
The company is rebuilding its business by concentrating more on higher margin and low risk products as against higher risk-capital intensive products. Now, more than 4/5th of its total premiums and deposits are in these lower-risk products.
Though this strategy leads to a somewhat modest growth relative to its historical pace, we expect the company to deliver more sustainable growth, improve product margins and earnings consistency in the long run.
Also, recently the company divested its Life Retrocession business Pacific Life Insurance. According to management, this business no longer offers an acceptable growth profile. We positively view management’s action to exit businesses where growth and return seem inadequate.
Manulife’s nature of business exposes it to significant market volatility. However, the company is effectively building its hedging program to decrease both interest rate and equity market exposures. During the third quarter, Manulife decreased its earnings sensitivity to both.
It has reached its 2014 goal of offsetting interest rate sensitivity and has already reached the 2012 goal for equity market sensitivity. If reasonable, Manulife further plans to decrease these exposures. We believe that these steps will help it to emerge as a stronger company, protecting it from becoming hostage to uncontrollable market variables.
Manulife has a diverse global presence with 75% of its earnings coming from outside Canada. Its presence in the Asian market for over a century also gives it a competitive advantage. Moreover, changing demographics has fueled the demand for insurance and wealth management products in these regions and the company will likely benefit from this due to its longstanding presence in the region.
However, Manulife faces some near term headwinds including declining global equity markets, low bond yields, an underperforming U.S. John Hancock business and declining capital levels.
For the past several quarters, the sharp decline in global equity markets coupled with low bond yields has forced Manulife to raise its reserves to guarantee future liabilities, thus stripping out more than C$1 billion ($992 million) from its bottom line.
We expect the global equity markets to remain weak and volatile in the near future. As a result, we anticipate higher reserve charges for its equity-linked products, which will weigh on its earnings per share. Though the company has made significant progress in reducing its exposures, it remains more exposed compared to its peers.
Manulife’s U.S. John Hancock business, which deals primarily in U.S variable annuities, is feeling the impact of low interest rates in the U.S. We expect continued under-performance from the U.S. operations where the rising cost of under-priced Variable Annuities, SGUL and LTC liabilities will translate into modest single-digit returns over time.
A look at the balance sheet shows that Manulife’s capital level, measured by Minimum Continuing Capital and Surplus Requirements Ratio (MCCSR), was 219% at the end of the third quarter, down from 234% last year and 241% in the previous quarter.
While the current level is well above the regulatory minimum of 150% (and Manulife’s internal targets, which are believed to be closer to 200%), we believe that the insurer might find it necessary to raise capital if low rates and falling stock markets persist in the upcoming months. These actions could range from issuing debt or equity to selling businesses.
Manulife closely competes with China Life Insurance Co. Ltd. (LFC) and Sun Life Financial Inc. (SLF).
CHINA LIFE INS (LFC): Free Stock Analysis Report
MANULIFE FINL (MFC): Free Stock Analysis Report
SUN LIFE FINL (SLF): Free Stock Analysis Report
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