Manulife Financial Corporation

Transcription

1 Title: Manulife Financial Corporation Price: Cdn$13.32 StockRating: Sector Perform TargetPrice: Cdn$14.00 Headline: Material Upside to Management Guidance September 15, 2014 The NBF Daily Bulletin MFC (T) Stock Rating: Target: Risk Rating: Cdn$22.04 Outperform (Was Restricted) Cdn$27.00 (Was Restricted) Below Average (Was Restricted) Est. Total Return 25% Stock Data: 52-w eek Low -High $ $22.53 Shares Outstanding EOP (mln) 1,858 Market Capitalization ($mln) $41,332 Quarterly Dividend Per Share $0.13 Dividend Yield 2.8% Price-to-Book 1.5x S&P/TSX Composite Weighting 2.11% (Year-End 12/31) 2013A 2014E 2015E 2016E EPS (Excl. Trust Unit Conv.) $1.44 $1.59 $2.14 $2.46 Y/Y Grow th 51% 10% 35% 15% Core EPS $1.57 $1.72 $1.98 $2.25 Y/Y Grow th 7% 9% 15% 13% MFC's Core EPS to Common $1.35 $1.57 $1.97 $2.29 Y/Y Grow th 15% 16% 25% 16% Dividend / Share $0.52 $0.57 $0.70 $0.82 F/D Avg. Shares 1,838 1,859 1,934 1,956 Book Value / Share $13.98 $15.54 $17.43 $18.84 Price / Book 1.6x 1.4x 1.3x 1.2x Price / Earnings 15.4x 14.0x 10.4x 9.1x Net Income to Common 2,999 2,948 4,119 4,739 NBF's Core Earn. from Ops. U.S. Insurance 1,117 1,202 1,304 1,392 U.S. Wealth Management ,062 1,178 Canadian Division 1,179 1,283 1,437 1,580 Asia & Japan Division 1,083 1,157 1,265 1,401 Corporate & Other (535) (395) (347) (337) NBF Core Earn. (pre-tax) 3,824 4,187 4,721 5,214 Taxes & Preferred Div. (934) (988) (1,249) (1,443) NBF Core Earn. (after-tax) 2,890 3,199 3,472 3,770 Inv. Gains, Hedge, Other (403) (272) (14) 90 MFC Core Earn. to Com. 2,486 2,926 3,822 4,484 Industry Rating: Overweight (NBF Economics & Strategy Group) Company Profile: Manulife is the largest Canadian Lifeco by market capitalization. The company s products portfolio includes life insurance, pensions, long-term care, mutual funds, annuities and group benefits. MFC's primary operations are in Canada and the U.S. (following the 2003 acquisition of John Hancock for $11 billion). MFC also has a sizeable presence in various Asian markets, with operations in the Philippines, Hong Kong, China, Taiwan, Indonesia, Singapore, Vietnam, Malaysia and Thailand. Peter Routledge - (416) peter.routledge@nbc.ca Associate: Parham Fini - (416) parham.fini@nbc.ca Associate: Paul Poon - (416) paul.poon@nbc.ca Manulife Financial Corporation Standard Life Canada Acquisition Insurance We Find Upside to Management Guidance on Accretion HIGHLIGHTS Resuming coverage following completion of MFC s subscription receipt offering to fund the purchase of Standard Life plc s Canadian operations. On Sept. 3, 2014, MFC announced an agreement to acquire Standard Life Canada (SLC) for Cdn$4 billion in cash. In connection with the transaction, MFC issued Cdn$1.76 billion in subscription receipts (including an overallotment option of 10%) along with a concurrent private placement of Cdn$500 million. MFC will fund the remaining amount through internal resources. Acquisition bolsters MFC s Canadian platform. The addition of SLC will double MFC s market share in the Canadian group retirement business, while also strengthening the insurer s group benefits and retail wealth management platforms in Canada. Material upside to management guidance on accretion. MFC has initially guided to accretion of approximately $0.03/share for each of the three years following the close of the acquisition, excluding transition and integration costs. In looking at the information available, we consider this guidance to be conservative, and the transaction certainly could reward MFC shareholders to a much greater extent. While MFC foresees revenue synergies as a long-term undertaking, the overlap in business lines suggests there exist material opportunities to realize medium-term expense efficiencies. Assuming SLC s expense base contracts by 25%, we estimate that accretion would be $0.05/share in f2015, rising to $0.10/share in f2017. Assuming Standard Life Canada s expense base could be reduced by 50%, the accretive upside becomes even more significant, ranging between $0.06/share in f2015 and $0.16/share in f2017. Note, in both scenarios we exclude integration costs. MFC remains at Outperform; price target increased to $27.00 from $ We incorporated into our estimates the assumption that MFC will reduce Standard Life Canada s expense base by 50%, given the broad overlap in existing operations. Thus, we expect the transaction to be materially accretive. Accordingly, we elected to raise our price target to $27 from $26. Our price target P/E multiple is 11.7x our NTM EPS one-year from today, a 2.7% discount to peers. MFC currently trades at 13.0x our forecasted EPS over the next twelve months (NTM), a 0.4% premium to peers. Stock Performance

2 Page 2 Price Target Increased to $27 from $26 on Accretion Upside On Sept. 3, 2014, MFC announced an agreement to acquire the Canadian-based operations of Standard Life plc for Cdn$4 billion in cash. The purchase price represents a 12.9x multiple to Standard Life Canada s annualized H1 f2014 earnings, and a 2.0x price to book value multiple. We view this as a moderate premium to fair value given that MFC s peers presently trade at 12.1x f2015 earnings on average, while Standard Life Canada s 14.7% ROE reasonably warrants a 1.9x book value multiple, based on Canadian life insurance company valuations over the past 18 months. As detailed further below, management expects the transaction to be accretive by approximately $0.03/share in each of the next three years, excluding transition and integration costs. In connection with this transaction, MFC issued Cdn$1.76 billion in subscription receipts (which included an overallotment option of 10%) along with a concurrent private placement of Cdn$500 million. MFC will fund the remaining amount through internal resources (and potential debt or preferred share issuances in the future). Management expects the transaction to close in the first quarter of f2015. Acquisition of Standard Life Canada Bolsters MFC s Canadian Platform Standard Life has a long presence in Canada dating back to 1883 and is the fifth largest life insurer in the country. Standard Life s Canadian operations comprise approximately 2,000 employees serving 1.4 million customers across the country with assets under management and assets under administration of approximately Cdn$52 billion (as at June 30, 2014). Standard Life Canada (SLC) operates through two business lines: Corporate and Retail. The former provides group pension and insurance solutions, while the latter represents an asset management platform including segregated funds, mutual funds and spread/risk products such as term investments and annuities (along with a now discontinued individual life insurance business). Figure 1 - Standard Life Canada - Net Income Before Taxes; Cdn$; mlns $700 $600 $500 $400 $300 $200 $100 $0 f2010 f2011 f2012 f2013 H1 f2014 Source: Standard Life plc. financials; NBF analysis Standard Life s Canadian operations consist of two legal entities: Standard Life Financial Inc. and Standard Life Investments Inc. (SLI); both of which MFC will acquire. As illustrated in Figure 1, based on company disclosures, between f2010 and f2014, SLC generated operating profit (before-tax) of between Cdn$170 million to Cdn$572 million, reporting

3 Page 3 pre-tax operating income of Cdn$125.5 million in H1 f2014, or Cdn$251 million annualized. The acquisition of SLC bolsters MFC s already strong market positions in several business segments. Most notably, in the group retirement business, MFC will increase its assets under administration (AUA) by 87% to over Cdn$40 billion. As demonstrated in Figure 2, this results in MFC s market share rising to 32% from 17% prior to the transaction, vaulting the insurer to the #2 position in Canada, trailing SLF (40%) and in front of GWO (22%). Figure 2 - Group Retirement Market Share (%); Canada (f2013) Sun Life Manulife/Standard Life Great-West Life Manulife Standard Life Industrial Alliance Desjardins Co-operators 0% 10% 20% 30% 40% 50% Source: Fraser Group; NBF analysis MFC s group benefits platform will become the market share leader in the country, from a #3 position previously, with share increasing to 23% from 21%. SLF and GWO follow closely behind at 22% and 21%, respectively. We note that on a geographic basis, SLC s market share in Québec amounted to 3%, compared with 2% in the rest of Canada (see Figures 3 and 4). Figure 3 - Group Benefits Market Share (%); Canada (f2013) Manulife/Standard Life Sun Life Great-West Life Manulife Blue Cross* Desjardins Financial SSQ Financial Group Green Shielf Industrial Alliance Standard Life 0% 5% 10% 15% 20% 25% Note: Market share data for Blue Cross represents the aggregate of all Blue Cross plans across Canada Source: Fraser Group; NBF analysis

4 Page 4 Figure 4 - Group Benefits Market Share (%); Québec (f2013) 0% 5% 10% 15% 20% 25% Desjardins Financial SSQ Financial Group Manulife/Standard Life Manulife Sun Life Great-West Life Industrial Alliance Capitale Blue Cross* Standard Life Empire Life Note: Market share data for Blue Cross represents the aggregate of all Blue Cross plans across Canada Source: Fraser Group; NBF analysis For individual life insurance, MFC s market share in Québec (as illustrated in Figure 5) will rise to 13% from 10%, making MFC the third largest player in the province (trailing Desjardins and IAG at 18% and 14%, respectively). However, as noted above, SLC discontinued its individual life insurance business, which is now in run-off. Figure 5 - Individual Insurance Market Share (%); Québec (f2012) Desjardins Financial Industrial Alliance Manulife/Standard Life Sun Life Manulife SSQ Financial Group Great-West Life Capitale London Life Canada Life Standard Life Empire RBC Transamerica National Bank ADM BMO Other 0% 5% 10% 15% 20% Source: Autorité des marchés financiers ; NBF analysis

5 Page 5 By enhancing its Canadian Group Retirement platform, MFC s management has better positioned the company to take advantage of structural shifts taking shape across the Canadian pension landscape. As smaller employers establish Pooled Registered Pension Plans (PRPP) for their employees, MFC has an opportunity to increase its penetration in the small-plan segment. Similarly, SLC s retail asset management platform adds additional scale and breadth in a highly sought after market space. To this end, MFC will increase its mutual fund assets under management by Cdn$5.4 billion or 20% (based on 2013 year-end figures from the Investment Funds Institute of Canada). While MFC s management hailed the acquisition of Standard Life Canada as a means of anchoring the insurer s presence in an underrepresented market, Québec, the market data above particularly for Group Benefits and Individual Insurance suggests that SLC s franchise is more pan-canadian than Québec-centric, despite the fact that the company s operations are based in Québec. Thus, we see this acquisition as less a play on the Québec market, and more a consolidation of Standard Life Canada s Québec-based platform into MFC Canada s operations. Upside to Management Guidance on Accretion is Material For the purpose of modeling this transaction, we utilized Standard Life s disclosures to the Office of the Superintendent of Financial Institutions (OSFI) for the Standard Life Assurance Company of Canada as a proxy for the enterprise. We acknowledge that this omits Standard Life Investments Inc. which does not come under OSFI supervision. Standard Life plc, however, reported that this unit did not contribute meaningfully to earnings in 2013 or in the first half of MFC disclosed that the addition of Standard Life Canada will not impact MFC s interest rate or equity market risk profile, and thus tail risk. Furthermore, MFC has targeted an MCCSR ratio of between 235% and 240% and a financial leverage ratio of 28% both of which signal management intends to maintain MFC s financial flexibility at levels similar to those prior to the SLC acquisition announcement. Therefore, we do not see MFC s balance sheet stability changing materially when this transaction closes in Q1 f2015. As a result, this deal will not impede the insurer s ability to increase its dividend at the trajectory that we forecasted at the end of last quarter. MFC expects to generate annual costs savings of Cdn$100 million to be largely realized by the third year after close. The company will also incur integration costs totaling Cdn$150 million after-tax in the first three years following the acquisition. In its transaction announcement, MFC initially guided to accretion of approximately $0.03/share for each of the next three years (f2015-f2017), excluding transition and integration costs. In looking at the information available, we consider this guidance to be conservative, and the transaction appears to have more earnings upside than initially estimated by MFC s management. In arriving at this conclusion, we start with a base case scenario of the contribution SLC s operations would provide to MFC on a standalone basis, ignoring the impact of any expense synergies realized after merging SLC s operations into MFC s Canadian platform. In Table 1, we illustrate our forecast base case. Under this scenario, we project that in each of the next three fiscal years, Standard Life s Canadian operations would contribute $0.04 to EPS in the first year, $0.05/share in the second year and third year. Thus, even our base case scenario would come in above management guidance.

6 Page 6 Table 1 - Contribution of Standard Life Canada - Base case Manulife f2015 f2016 f2017 Shares Outstanding 1,877 1,865 1,837 Net Income to Common Shareholders 3,903 4,358 4,532 EPS $2.08 $2.34 $2.47 Standard Life Canada Net Income to Common Shareholders Combined Shares Outstanding 1,934 1,956 1,929 Net Income to Common Shareholders 4,094 4,665 4,852 EPS $2.12 $2.38 $2.51 Accretion/(Dilution) $0.04 $0.05 $0.05 Note: Our estimates for MFC have been updated for interest rate movements since the last quarter. Net income to common shareholders and EPS excludes integration costs. Source: Company financials; NBF analysis While MFC foresees significant revenue synergies in this acquisition, management indicated that realizing this potential will likely be a long-term undertaking, extending beyond the three-year guidance horizon. That said, the overlap in business lines suggests there exist material opportunities to extract medium-term expense efficiencies (recall MFC projects Cdn$100 million in cost synergies after-tax to be largely achieved by the third year following the transaction). In assessing the potential impact to MFC s earnings from Standard Life Canada, we consider two scenarios. In Table 2, we present our forecasted accretion assuming that MFC reduces SLC s general expense base by 25% in the three years following the transaction. In Table 3, we provide our forecasted earnings accretion assuming MFC reduces SLC s run-rate general expense base by 50%. In forecasting expense synergies, we assume no benefits through the first three quarters following the acquisition s close, with efficiencies accelerating thereafter and settling into the assumed run-rate by the third year following the transaction (i.e., f2017). Table 2 - Contribution of Standard Life Canada - Assuming 25% expense reduction Manulife f2015 f2016 f2017 Shares Outstanding 1,877 1,865 1,837 Net Income to Common Shareholders 3,903 4,358 4,532 EPS $2.08 $2.34 $2.47 Standard Life Canada Net Income to Common Shareholders Combined Shares Outstanding 1,934 1,956 1,929 Net Income to Common Shareholders 4,117 4,735 4,961 EPS $2.13 $2.42 $2.57 Accretion/(Dilution) $0.05 $0.08 $0.10 Note: Our estimates for MFC have been updated for interest rate movements since the last quarter. Net income to common shareholders and EPS excludes integration costs. Source: Company financials; NBF analysis

7 Page 7 Table 3 - Contribution of Standard Life Canada - Assuming 50% expense reduction Manulife f2015 f2016 f2017 Shares Outstanding 1,877 1,865 1,837 Net Income to Common Shareholders 3,903 4,358 4,532 EPS $2.08 $2.34 $2.47 Standard Life Canada Net Income to Common Shareholders Combined Operations Shares Outstanding 1,934 1,956 1,929 Net Income to Common Shareholders 4,141 4,806 5,071 EPS $2.14 $2.46 $2.63 Accretion/(Dilution) $0.06 $0.12 $0.16 Note: Our estimates for MFC have been updated for interest rate movements since the last quarter. Net income to common shareholders and EPS excludes integration costs. Source: Company financials; NBF analysis Assuming SLC s expense base contracts by 25%, accretion would rise to between $0.05/share and $0.10/share in f2017. Assuming MFC can reduce Standard Life Canada s expense base by 50%, the accretive upside becomes even more significant, ranging between $0.06/share in f2015 to $0.16/share in f2017. Note, in both scenarios we exclude integration costs. Based on the scenarios detailed above, we believe the potential for earnings accretion from the acquisition of Standard Life Canada could be well in excess of MFC s guidance. Acquisition Increases Our Price Target to $27 from $26 We base our Outperform rating on the view that a new era has begun at MFC one in which shareholders will see capital flow back to them (a reversal from the financial crisis years) in the form of increasing dividends, common share repurchases and accretive acquisitions. The purchase of Standard Life Canada fits well within our rating and valuation thesis. In adjusting our estimates, we incorporated the assumption that MFC will reduce Standard Life Canada s expense base by 50%, given the broad overlap in existing operations. Based on the analysis herein, we expect the transaction to be materially accretive. As a result of the SLC transaction and an update for prevailing interest rates, our estimated EPS falls to $1.59 from $1.60 in f2014, but increases to $2.14 from $2.07 in f2015, and to $2.46 from $2.32 in f2016. Accordingly, we elected to raise our price target to $27 from $26. Our price target P/E multiple is 11.7x our NTM EPS one-year from today, a 2.7% discount to peers. MFC currently trades at 13.0x our forecasted EPS over the next twelve months (NTM), a 0.4% premium to peers.

8 Page 8 Manulife Financial Corporation Snapshot Prior Four Quarters Last Next Four Quarters Years Ending Core Earnings from Operations ($mln) 2Q-13A 3Q-13A 4Q-13A 1Q-14A 2Q-14A 3Q-14E 4Q-14E 1Q-15E 2Q-15E 2013A 2014E 2015E 2016E U.S. Insurance ,117 1,202 1,304 1,392 U.S. Wealth Management ,062 1,178 Canadian Division ,179 1,283 1,437 1,580 Asia & Japan Division ,083 1,157 1,265 1,401 Corporate & Other (221) (147) (59) (106) (114) (88) (87) (85) (85) (535) (395) (347) (337) Total Core Earnings from Ops. (pre-tax) $ 892 $ 936 $ 1,012 $ 1,003 $ 1,004 $ 1,075 $ 1,105 $ 1,129 $ 1,153 $ 3,824 $ 4,187 $ 4,721 $ 5,214 Taxes (at run-rate effective corporate tax rate) (187) (197) (212) (211) (211) (218) (224) (237) (288) (803) (863) (1,139) (1,332) Preferred Share Dividends (32) (33) (34) (34) (36) (28) (27) (27) (28) (131) (126) (110) (112) Total Core Earnings From Ops. (after-tax) $ 673 $ 706 $ 765 $ 758 $ 757 $ 829 $ 854 $ 864 $ 948 $ 2,890 $ 3,199 $ 3,472 $ 3,770 Core Investment Gains Macro Hedge Cost (128) (84) (53) (42) (49) (45) (40) (35) (30) (413) (176) (105) (40) Other (16) (3) (111) (81) (93) (62) (59) (56) (54) (190) (296) (209) (170) Reported MFC Core Earnings to Common $ 577 $ 671 $ 651 $ 685 $ 665 $ 772 $ 804 $ 848 $ 940 $ 2,486 $ 2,926 $ 3,822 $ 4,484 Reported MFC Core Earnings (before Prefs) $ 609 $ 704 $ 685 $ 719 $ 701 $ 800 $ 832 $ 875 $ 967 $ 2,617 $ 3,052 $ 3,932 $ 4,596 Prior Four Quarters Last Next Four Quarters Years Ending Enterprise Sources of Earnings Stmnt ($mln) 2Q-13A 3Q-13A 4Q-13A 1Q-14A 2Q-14A 3Q-14E 4Q-14E 1Q-15E 2Q-15E 2013A 2014E 2015E 2016E Expected profit from in-force bus ,010 1,036 1,057 3,691 3,874 4,272 4,631 Impact of new business (71) (55) (61) (79) (75) (56) (66) (76) (82) (263) (276) (311) (342) Experience gains (losses) (300) Manag. Actions & Change in Assum. (424) (593) 515 (88) (114) (446) (326) (44) (38) (799) (974) (133) (51) Earnings on surplus Other (12) (2) (22) Income before Income Taxes 156 1,206 1, , ,214 1,349 3,711 3,744 5,468 6,285 Income taxes 103 (172) (497) (133) (234) (106) (197) (269) (307) (581) (671) (1,239) (1,434) Net Income to Shareholders 259 1,034 1, ,042 3,130 3,074 4,229 4,851 Preferred Share Dividends (32) (33) (34) (34) (36) (28) (27) (27) (28) (131) (126) (110) (112) Net Income to Common 227 1,001 1, ,014 2,999 2,948 4,119 4,739 One-Time Items (incl. Std. Life Integration) - - (350) (350) Operating Net Income $ 227 $ 1,001 $ 913 $ 784 $ 907 $ 517 $ 740 $ 917 $ 1,019 $ 2,649 $ 2,948 $ 4,141 $ 4,806 EPS (Excl. MFCT Conversion) - excl. one-timers $0.12 $0.54 $0.49 $0.42 $0.49 $0.28 $0.40 $0.49 $0.53 $1.44 $1.59 $2.14 $2.46 % Growth (55%) 340% (9%) (14%) 15% (43%) 43% 24% 8% 51% 10% 35% 15% IFRS EPS $0.12 $0.54 $0.68 $0.42 $0.49 $0.28 $0.39 $0.49 $0.52 $1.62 $1.58 $2.12 $2.42 % Growth (57%) 350% 26% (38%) 17% (44%) 42% 24% 8% 93% (2%) 34% 14% Core EPS $0.37 $0.38 $0.41 $0.41 $0.41 $0.45 $0.46 $0.46 $0.49 $1.57 $1.72 $1.98 $2.25 % Growth (10%) 5% 8% (1%) (0%) 9% 3% 1% 7% 7% 9% 15% 13% MFC Reported Core EPS to Common $0.31 $0.36 $0.35 $0.37 $0.36 $0.41 $0.43 $0.45 $0.49 $1.35 $1.57 $1.97 $2.29 % Growth (2%) 16% (3%) 5% (3%) 16% 4% 5% 8% 15% 16% 25% 16% Return on Equity (Annualized) 4% 17% 20% 12% 13% 7% 10% 13% 13% 13% 11% 13% 13% Effective Tax Rate (66%) 14% 28% 14% 20% 16% 20% 22% 23% 16% 18% 23% 23% Dividends / Share $0.13 $0.13 $0.13 $0.13 $0.13 $0.16 $0.16 $0.16 $0.18 $0.52 $0.57 $0.70 $0.82 Common Div. Payout Ratio 106% 24% 19% 27% 27% 56% 39% 32% 35% 32% 35% 33% 34% F/D Avg. Shares O/S (Excl. MFCT Conversion) 1,836 1,841 1,846 1,851 1,856 1,862 1,867 1,871 1,921 1,838 1,859 1,934 1,956 IFRS F/D Avg. Shares O/S 1,860 1,864 1,869 1,874 1,878 1,881 1,882 1,887 1,936 1,862 1,879 1,941 1,956 Reported Items of Note ($mln) (after-tax) Credit Impairments and Dow ngrades (6) Equity Market Impact on Earnings (226) (73) 55 (60) (78) - - Interest Rate Impact on Earnings 24 (149) (160) 6 14 (46) (538) (2) Impact of Assumption Changes & Mngt Actions (incl. URR) (233) (399) (212) (107) (109) (322) (240) (35) (30) (1,158) (778) (105) (40) Hedging Ineffectiveness Investment Gains (Core & Non-core) (49) Other (incl. Goodw ill Impairment) 24 (3) 594 (8) Total $ (407) $ 299 $ 609 $ 103 $ 237 $ (303) $ (91) $ 67 $ 151 $ 327 $ (53) $ 577 $ 826 Assets under Management ($bln) Expected Profit to Average AUM 0.68% 0.64% 0.60% 0.60% 0.61% 0.60% 0.60% 0.61% 0.58% 0.65% 0.60% 0.57% 0.55% Avg. AUM to Avg. Common S/E 24.3x 24.2x 23.7x 23.0x 22.9x 23.1x 23.3x 23.4x 23.4x 23.9x 23.2x 23.4x 23.7x Prem. and Deposits (excl. Corporate) 22,533 19,613 20,579 23,269 22,223 23,435 24,020 24,700 25,238 84,276 92, , ,337 Strain to Prem. & Deposits (excl. Corporate) (0.31%) (0.27%) (0.30%) (0.33%) (0.34%) (0.24%) (0.27%) (0.31%) (0.33%) (0.31%) (0.30%) (0.30%) (0.31%) Earnings on Surplus to Avg. Common S/E 0.28% 1.11% 2.85% 2.50% 1.61% 2.15% 2.22% 2.32% 2.28% 1.67% 2.12% 2.38% 2.61% Book Value per Share MCCSR Ratio 222% 229% 248% 255% 243% 239% 239% 238% 219% 248% 239% 211% 212% Note: Core earnings are the after-tax sum of expected profit, new business strain and earnings on surplus. Source: Company financials; NBF analysis