Friday, November 26, 2010

Manulife (MFC) - It's not so bad...

This is the first post on my new blog. I thought I would start with a discussion about a company that I have recently added that embodies the classic definition of a value investment. It's definitely unloved and out of favour right now (Citigroup just downgraded  to sell). That's Manulife Financial (MFC). There has been no shortage of bad press regarding MFC over the past couple of years. MFC was one of the shining stars of the Canadian markets until 2008 when the financial crisis hit. The market scalped MFC off billions in market cap ( rightly so ) as result of previous management's choice not to hedge many of their guaranteed investment products ( variable annuities - VA ) to falling equity markets. This severely hurt their capital position, resulting in a massive equity raise and significant write downs and a dividend cut. Although, raising capital & the dividend cut was the right thing to do, shareholders didn't like it. Many people saw there holdings sink from $40 to a diluted $10 and sold. I should also note that many of the other Canadian and US life insurer's suffer from the same issues, but to varying degrees. Low interest rates have been hard on the insurer's large bond holdings.
The new management team has steadily increased their hedging program to limit exposure to VA's. MFC is not out of the woods yet, however things are improving as evidenced by their Q3 earnings ( excluding non-cash charges ) of 779 Million. Management has guided for net earnings of 4 billion by 2015, which is similar to their earnings power from 2005 through 2007. I think this is conservative, considering their growth rates in Asia. Many people continue to look at MFC through the rear view mirror ( focusing on all the errors they made ) and not looking out of the windshield. MFC's suite of assets (Manulife Canada, John Hancock, Manulife Japan, Manulife China and Manulife Asia) are all still well positioned in their respective markets. Equity markets are improving. Though, many refuse to believe it. Also, it's likely rates will rise in the years to come. All good for MFC. Management is committed to maintaining a strong balance sheet and limiting exposures to VA's. Going forward MFC will not likely return to the ROE's that they had become accustomed to. All that said, MFC can still be a fine investment going forward, especially when the love returns to the insurance stocks.

So, I first bought an opening position in MFC in June @ $16. I added significantly to MFC in October @ $12 and change. MFC yields 4.2%. After crunching the numbers, it appears MFC is worth somewhere in the range of $26-$32 a couple of years out. If I'm wrong it's likely that I won't lose too much money from these levels. I'll sit patiently and collect the coupon.


1 comment:

  1. Historically, MFC's performance has tended to track the TSX's performance fairly closely, primarily because of MFC's massive equity portfolio. However, since the depths of the recent crash (Feb 2009), MFC's performance has de-coupled from that of the TSX because of fears that its VA's and overall equity exposure would force them to undertake drastic capital structure measures to bolster their capital ratios (i.e. dilutive share issues on a depressed stock price and/or dividend cuts). These measures have not materialized and they are becoming less likely as the market continues it tenuous recovery.

    Unless something fundamentally changes with respect to (1) MFC's business model (2) MFC's exposure to equity markets or (3) MFC's capital structure, it seems reasonable to assume that the stock performance will re-couple with the TSX’s performance at some point in the relatively near future (i.e. the next 6-12 months). This, of course, can be accomplished in two ways: (1) MFC rises more rapidly than the TSX rises or (2) MFC falls less rapidly than the TSX falls. I think scenario 1 is more likely. As such, I agree that MFC is a sound long-term investment at an average cost in the $12-14 range.