Lifeco rally still has legs, analysts say

Canadian firms outperforming equity market

Canadian life insurance stocks have rallied hard this year due to rising bond yields and stronger equity markets, but valuations remain attractive enough to support some further gains in the near term, say analysts.

“Until this sentiment changes, we see little reason to believe that additional near- term upside or, support for current valuations at a minimum, is not available,” said John Aiken, a Barclays analyst.

Manulife Financial Corp., Sun Life Financial Inc. and Great- West Lifeco Inc. have all easily outperformed the broader Canadian equity market in 2013, rising 33%, 23% and 27%, respectively, since the beginning of the year.

All three stocks are at 52- week highs this week, but remain well off their pre- financial- crisis peaks to varying degrees. Mr. Aiken said the strong run has been supported by a reversal in the market factors that had punished insurance company shares over the past five years.

More specifically, he said they are benefiting from a steady rise in government bond yields in Canada and south of the border, and “largely positive” stock markets around the world.

The rally has pushed lifeco valuations above long- term averages, but Mr. Aiken isn’t concerned given the group’s trading range over the past 10 years.

“Manulife is trading at a slight premium to its long- term average and Great West Life is trading at less than a one point premium,” he noted. “Both have significant room to move before hitting their historical highs.”

The same goes for Sun Life, which is trading at a price/ earnings multiple barely above its long- term average.

But Mr. Aiken said analyst estimates for all three insurers only need to modestly increase to eliminate the premium multiple.

“In addition, transitioning to 2014 as the valuation year, gets the multiples back below the long- term average for each,” he said.

Andre- Philippe Hardy, an RBC Capital Markets analyst, seems less optimistic about the potential upside for lifecos.

He believes second - quarter earnings due out in early Au - gust will benefit from a higher interest- rate environment and higher corporate spreads, but more volatile equity markets of late and higher swap rates should act as a headwind.

Mr. Hardy added that valuations for the group, including Industrial Alliance Insurance and Financial Services Inc., fully reflect forward earnings and return- on- equity estimates, resulting in limited multiple expansions for some companies in the medium term. “Valuations of 1.3- 1.4x book value fully reflect 2013- 2014 expected ROEs of approximately 11- 12%, in our view, as do P/ E multiples higher than the Canadian bank group,” he said.

“Of the four lifecos, if we had to invest in one, it would be Manulife as we believe that it has more upside when considering medium- term EPS and ROE potential.”