February 12, 2015 Genworth Financial Inc. Current Recommendation Prior Recommendation Neutral Date of Last Change 08/22/2014 Current Price (02/11/15) $8.33 Target Price $7.50 SUMMARY DATA UNDERPERFORM 52-Week High $18.60 52-Week Low $6.93 One-Year Return (%) -46.01 Beta 1.98 Average Daily Volume (sh) 5,965,062 Shares Outstanding (mil) 497 Market Capitalization ($mil) $4,140 Short Interest Ratio (days) 1.37 Institutional Ownership (%) 78 Insider Ownership (%) 0 Annual Cash Dividend $0.00 Dividend Yield (%) 0.00 5-Yr. Historical Growth Rates Sales (%) -0.7 Earnings Per Share (%) 20.2 Dividend (%) N/A using TTM EPS N/A using 2015 Estimate 6.7 using 2016 Estimate 6.0 Zacks Rank *: Short Term 1 3 months outlook 5 - Strong Sell * Definition / Disclosure on last page (GNW-NYSE) SUMMARY Genworth incurred a loss in the fourth quarter that compared unfavorably with Zacks Consensus Earnings Estimate and the year ago earnings. Results suffered due to substantial loss at its long-term care (LTC) business. However, solid competitive positions, improving market dynamics, and favorable loss ratio performance continue to favor mortgage business performance and expects to sustain the momentum. Delinquencies also declined from the year-ago level. Moreover, a new credit line and redemption of 2015 notes along with an increase in cash balance enhanced Genworth s financial position. Genworth aims for a leverage of 20% to 22% over the medium term. Genworth intends rationalize costs that will generate annual cash savings of over $100 million in the next couple of years. The company also remains focused to satisfy GSE capital requirements, largely through reinsurance. We retain our Underperform recommendation. Risk Level * Above Avg., Type of Stock Large-Value Industry Ins-Life Zacks Industry Rank * 215 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 2,303 A 2,371 A 2,317 A 2,412 A 9,403 A 2014 2,322 A 2,415 A 2,431 A 2,434 A 9,565 A 2015 2,464 E 2,474 E 2,512 E 2,392 E 9,845 E 2016 10,156 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.30 A $0.27 A $0.24 A $0.38 A $1.24 A 2014 $0.39 A $0.31 A -$0.64 A -$0.84 A -$0.77 A 2015 $0.31 E $0.31 E $0.31 E $0.32 E $1.25 E 2016 $1.38 E Projected EPS Growth - Next 5 Years % 5 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 111 North Canal Street, Chicago IL 60606
RECENT NEWS Genworth Incurs Loss in Q4 on Soft Long-Term Care Business Feb 11, 2015 Genworth Financial Inc. posted fourth-quarter operating net loss of $0.84 per share, widely missing the Zacks Consensus Estimate of $0.09 earnings per share. Results also compared unfavorably with $0.38 per share earned in the year-ago quarter. Including net investment gains of $4 million, goodwill impairment of $274 million and tax impact from potential business portfolio changes of $66 million, net loss of $1.53 per share was incurred against $0.41 earned in the year-ago quarter. Genworth s results suffered due to substantial loss at its long-term care (LTC) business. Operational Performance Total revenue of Genworth inched up 0.5% year over year to $2.4 billion. The uptick was backed by higher premiums (up 5.8%). Revenues were in line with the Zacks Consensus Estimate. Total benefits and expenses increased about 60% year over year to $3.3 billion due to higher benefits and other changes in policy reserves and goodwill impairment recorded in the quarter. Full-Year 2014 Review The company digested operating net loss of $0.77 per share against earnings of $1.24 per share in 2013. Genworth also witnessed net loss of $2.51 per share versus net profit of $1.12 per share in 2013. Revenues of $9.6 billion improved 1.7% year over year. Segment-wise Quarterly Review U.S. Life Insurance: The segment reported net operating loss of $482 million against $119 million profit in the year-ago quarter. Huge loss incurred in long-term care insurance and soft-performing fixed annuities business were responsible for the debacle. Loss at long-term care insurance reflected the completion of the annual review of its LTC active life margins, resulting in after-tax charges of $478 million on its acquired blocks. Global Mortgage Insurance: The segment s net operating income of $83 million decreased 22% year over year. Though profits at U.S. Mortgage Insurance improved, lower profit at International Mortgage Insurance resulted in overall decline. Corporate and Run-Off: Net operating loss was $17 million, narrower than $33 million loss incurred in the year-ago quarter. Financial Update Genworth exited 2014 with cash, cash equivalents and invested assets of $78.8 billion, up 7.3% from 2013 end. Long-term borrowings of Genworth totaled $4.6 billion as of Dec 31, 2014, down about 10% from $5.2 million at 2013 end. Equity Research GNW Page 2
Business Updates Genworth is undertaking a restructuring plan, which is expected to generate a pre-tax cash savings of over $100 million in the next couple of years. Genworth is consolidating its U.S. Life Insurance Division and corporate holding company functions, which is resulting in headcount reduction. In connection with the divestiture of the lifestyle protection insurance business, Genworth completed an internal debt restructuring, thus recognizing $108 million in tax benefits in the reported quarter. VALUATION The shares of Genworth currently trade at 6.7x our 2015 earnings estimate, a 48% discount to the industry average of 13.0x. On a price-to-book basis, the shares trade at 0.2x, which is at a 80% discount to the 1.0x industry average. On a price-to-book basis the valuation seems stretched, given that the trailing-twelve-month ROE is below the industry average. Our six-month target price of $7.50 equates to 6.0x our earnings estimate for 2015. With no dividend supplement, the target price implies a return of about negative 10.0% over that period. This is consistent with our Underperform recommendation on the shares. Additionally, the quantitative Zacks Rank for Genworth is currently 5, indicating downward directional pressure on the shares over the near term. Short interest is currently 1.4 days. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Genworth Financial Inc. (GNW) 6.7 6.0 5.0 3.5 NA 61.2 8.2 Industry Average 13.0 11.5 9.2 11.4 30.4 115.9 8.5 S&P 500 16.5 15.4 10.7 15.1 19.0 19.4 12.0 Reinsurance Group of America Inc. (RGA) 10.1 9.2 NA 23.5 9.6 16.2 6.1 Voya Financial, Inc. (VOYA) 12.8 11.4 8.1 7.4 14.3 14.6 9.4 Torchmark Corporation (TMK) 12.3 11.2 8.2 7.5 13.2 13.9 7.8 StanCorp Financial Corporation (SFG) 12.6 11.4 2.4 8.4 12.7 13.5 7.7 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Genworth Financial Inc. (GNW) 0.2 0.6 0.1 1.3 0.3 0.0 2.5 Industry Average 1.0 1.0 1.0 7.7 NA 1.1 3.9 S&P 500 5.3 9.8 3.2 25.5 2.1 Equity Research GNW Page 3
Earnings Surprise and Estimate Revision History NOTE THIS IS A NEWS-ONLY UPDATE; THE REST OF THIS REPORT HAS NOT BEEN UPDATED YET. Equity Research GNW Page 4
OVERVIEW Based in Richmond, VA, Genworth Financial Inc. (GNW) was spun off from General Electric s life and mortgage insurance operations through its May 2004 initial public offering. Operating in more than 25 countries, Genworth has a leading position in the U.S., and an expanding presence in Canada, Australia, U.K. and several continental European countries. The company offers a variety of products to more than 15 million customers in areas such as life insurance and lifestyle protection, long-term care insurance, annuities, asset management and mortgage insurance through financial intermediaries, advisors, independent distributors and sales specialists. On April 1, 2013, Genworth Holdings (formerly named Genworth Financial, Inc.) completed a holding company reorganization whereby Genworth Holdings became a direct, wholly-owned subsidiary of a new public holding company, New Genworth. Effective 4Q11, the company started operating through three divisions with six underlying reporting segments. The Insurance and Wealth Management Division includes U.S. Life Insurance (includes life insurance, long-term care insurance and fixed annuities businesses), International Protection (includes lifestyle protection insurance business) and Wealth Management. The Mortgage Insurance Division includes International Mortgage Insurance and U.S. Mortgage Insurance. The Corporate and Runoff Division includes the Runoff segment and Corporate and Other activities. The Runoff segment includes the results of non-strategic products, which are no longer actively sold. U.S. Life Insurance The company offers and manages an array of insurance and fixed annuity products. Primary insurance products include life and long-term care insurance. International Protection Genworth is a leading provider of payment protection coverages (referred to as lifestyle protection) in multiple European countries. The lifestyle protection insurance products primarily help consumers meet specified payment obligations should they become unable to pay due to accident, illness, involuntary unemployment, disability or death. International Mortgage Insurance Genworth Financial is a leading provider of mortgage insurance products and related services in Canada, Australia, Mexico and multiple European countries. The products predominantly insure prime-based, individually underwritten residential mortgage loans, also known as flow mortgage insurance. On a limited basis, it also provides mortgage insurance on a structured or bulk basis that aids in the sale of mortgages to capital markets and helps lenders manage capital and risk. Additionally, the company offers services, analytical tools and technology that enable lenders to operate efficiently and manage risk. U.S. Mortgage Insurance In the United States, the company offers mortgage insurance products predominantly insuring prime-based, individually underwritten residential mortgage loans, also known as flow mortgage insurance. It selectively provides mortgage insurance on a bulk basis with essentially all of prime-based bulk writings. Additionally, it offers services, analytical tools and technology that enable lenders to operate efficiently and manage risk. Runoff The Runoff segment includes the results of non-strategic products which are no longer actively sold. Non-strategic products include variable annuity, variable life insurance, institutional, corporateowned life insurance and Medicare supplement insurance products. Institutional products consist of funding agreements, FABNs and GICs. In Jan 2011, the company discontinued new sales of retail and group variable annuities while continuing to service existing blocks of business. Effective Oct 1, 2011, the sale of Medicare supplement insurance business was completed. Equity Research GNW Page 5
Corporate and Other The segment includes debt financing expenses that are incurred at the holding company level, unallocated corporate income and expenses, elimination of inter-segment transactions and the results of other non-core businesses that are managed outside the operating segments. On Mar 27, 2013, Genworth agreed to sell its wealth management business to AqGen Liberty Acquisition, Inc., a subsidiary of AqGen Liberty Holdings LLC, a partnership of Aquiline Capital Partners and Genstar Capital, for approximately $412 million. As of Sep 30, 2014, Genworth had $110.5 billion (up 2.3% year over year) in assets, $4.7 billion (down 2.1% year over year) in long-term borrowings and $15.2 billion (up 4.1% year over year) in stockholder equity. REASONS TO SELL The introduction of new products and pricing changes in the U.S. Life Insurance Division implemented over the past couple of years led to lower sales for Genworth. Though, life insurance sales improved 88% year over year in the first nine months of 2014 on the back of gradual growth of reintroduced term life insurance products that the company started offering in the fourth quarter of 2012, long-term care insurance sales continue to deteriorate, having declined 37% year over year in the first nine months of 2014. Nonetheless, with the company offering permanent life product services, a goodwill impairment of $350 million was reported in the third quarter. This resulted in the loss incurred in the quarter. Loss ratios of long-term care insurance business have been increasing over the past several years and have ranged from 63% to 68% over the last five years. Due to review of and changes to claim reserve assumptions, it deteriorated to 173% in the third quarter. The company expects volatility in loss ratio given rate actions and if policyholders choosing a reduced benefit option. The company expects loss ratio within 25 30% in 2014. The company envisions sales in U.S. Life division to be two-thirds of long-term care insurance and one-third of life insurance in the near term. However, it expects a balanced mix of life and long-term care sales over time, as new products gain momentum in the market. Nonetheless, management projects 2014 earnings at U.S. Life Insurance Division to be 5 10% higher than the 2013 level on an improvement in long-term care from the rate actions. Genworth experienced a substantial increase in adverse claims experience for long-term care insurance products. It largely stemmed from higher severity on both new and existing claims as well as an increase in new claims. This in turn considerably weighed on the operating income of the company. Adding to the bottom line woes were an increase in claim reserves during the quarter that was a result of comprehensive review of long-term care insurance claim reserves conducted over the past few months. Investment results continue to witness a downturn and the last quarter was no exception. Net investment income witnessed a 0.5% decline through the first three quarters of 2014. Annualized weighted-average investment yields also declined 10 basis points in the last quarter due to lower reinvestment yields on higher average invested assets. Given a soft interest rate environment, we do not expect any immediate turnaround in investment results. RISKS After incurring losses over an extended period, the mortgage business started reporting profit. For the seventh consecutive quarter, the mortgage insurance segment generated a profit, largely on the heels of substantial lower loss at U.S. Mortgage Insurance. Lower new delinquency development and Equity Research GNW Page 6
effective loss mitigation programs along with changes in aging of existing delinquencies particularly aided the improvement in U.S. Mortgage Insurance. Gradual improvement in the U.S. housing market, strong loss mitigation programs and a growing private mortgage insurance market helped in increasing new insurance written and lower losses. Loss mitigation saving is expected between $250 million and $350 million. Further, total flow delinquencies declined 26% year over year, and new delinquencies 18% year over year, with new business remaining quite profitable. The company expects the momentum to continue with substantially higher earnings in 2014 over the 2013 level. Genworth also anticipates delinquency to decline 15% to 20% in 2014. Additionally, performance at Canada was stable with Australia emerging with better numbers. As a result, the company executed the initial public offering of its Australian unit. However, management expects results to be weighed upon by lower U.S. tax benefits and lower foreign exchange rates. Additionally implementation of its U.S. Mortgage Insurance Capital Plan is expected to lower Genworth Mortgage Insurance Company's (GMICO), the main U.S. mortgage insurance subsidiary, risk-to-capital by 12 to 15 points. Under the plan, Genworth s mortgage insurance subsidiaries will likely have surplus capital in the near future. Further, the plan should enhance the company s new business writing capability and lower the default risk under the agreement covering its senior notes. The company also remains focused to satisfy new GSE capital requirements on US mortgage, largely through reinsurance. In third-quarter 2012, Genworth filed for rate increases for its long-term care in force premium. The company expects $250 million to $300 million of additional annual premiums when fully implemented over the next five years. It received approvals from 47 states with net incremental premiums of about $190 200 million. The company is yet to receive approval from 8 states with expected premiums of $25 $45 million and has filed for approval in 30 more states with incremental premiums of $30 $55 million. It expects incremental premium recognized in 2014 between $120 million and $140 million The company estimates about 84% of its policyholders agreeing to pay the approved rate increases. It has also started filing for 6% to 13% rate increases on long-term care products (issued in the beginning of 2003 and written through 2012). Current premiums on these policies are in the range of $800 million. 2014 earnings are likely to be benefited by $150 million to $175 million from the rate actions. In addition, in the fourth quarter of 2013, the company began filing for regulatory approval of a new product. As of Sep 30, 2014, the company had already filed in 50 states, got approval in 47 states and was launched in 42 states on July 21, 2014. Though the company expects sales to be lower in the fourth quarter of 2014, it expects the same to accelerate in 2015. Genworth has been strengthening its financial position. Cash from operations surged almost 134% in 2011, slumped 69% in 2012, and once again, bounced back to an improved 45% in 2013. The first nine months also witnessed a 4.3% improvement. The company is also effectively lowering its debt to capital ratio over the years. It improved 800 basis points (bps) in 2011 and by 200 bps in 2012. Though the ratio deteriorated by 600 bps to 33% as on Dec 31, 2013, it improved 290 bps at thirdquarter end. The company has addressed its debt maturities till Dec 2016. The company s $400 million new debt and a new 3-year credit facility of $300 million increased financial flexibility, allowing it to reduce the amount of cash required to maintain at the holding company level. DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of GNW. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve Equity Research GNW Page 7
months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1121 companies covered: Outperform - 15.3%, Neutral - 76.8%, Underperform 7.2%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research GNW Page 8