National Bank National Bank Financial analyst Gabriel Dechaine is turning “more cautious” on Canadian life insurance companies heading into 2024.
“The lifecos have been strong performers over the past two years, relative to the market and to the Big-6,” he said. “We believe that performance will be more subdued in the coming year, reflecting: 1) valuation multiples that are above their historical average and that reflect a wider than normal premium to the Big-6 banks on a P/B basis; 2) Street expectations that are nearing double-digit growth; and 3) a historical track record of margin compression during periods of Central Bank loosening.
“Our top pick in the space is IAG, which we believe offers attractive valuation, a flexible balance sheet and potentially improving financial performance in its P&C operations in Canada and the U.S. in 2024.”
In a research report released Tuesday, Mr. Dechaine argued one of the “biggest risks” to the performance of the industry’s stocks is a rebound in the Canadian banks. He also warned the implementation of a IFRS 17 accounting principles will continue to be “a net negative for sector valuation.”
“Lifecos outperformed the market in 2023 by 13 per cent,” he said. “Also noteworthy, they outperformed the Big-6 banks for the second consecutive year, which is a rare occurrence. We recently turned positive on the banks ... as we believe rate cut activity reduces downside risk to the Canadian housing market and to the broader economy.”
“In our view, the adoption of IFRS 17 has been a net negative for sector valuation, if only because of its inherent instability. Core EPS was 30 per cent above Reported EPS over year-to-date 2023. Such a variance reduces confidence in consensus forecasts and in the definition of Core EPS itself, which varies between companies. Another factor worth noting is the heavy emphasis on the Contractual Service Margin as a measure of value, as it represents future ‘locked in’ earnings. While mostly true, nearly two-thirds of CSM earnings emergence will take place over five years from now.”
Ahead of the start of fourth-quarter 2023 earnings season, he maintained his forecast through 2024 while introductng 2025 earnings per share projections that imply growth of 7 per cent on average.
With that view, he raised his target prices for stocks in his coverage universe by an average of 6 per cent, despite seeing “uncompelling” valuations.
“Earnings multiples garnered by the lifecos appear attractive, at least in a superficial manner,” he said. “On a standalone basis, the group’s 9.3 times forward P/E multiple represents an 7-per-cent discount to the 10-year 10.0 times historical average. On a relative basis, the lifecos are trading at a discount of 11 per cent to the Big-6 banks, as opposed to the historical average discount of 8 per cent. Now one could simply state that these valuation metrics are attractive. However, since we believe IFRS 17 has reduced the reliability of earnings forecasts in the sector ... we would counter-argue that these discounts are warranted. Moreover, other valuation measures and trends paint a different picture for the lifeco sector.
“In contrast to earnings multiples, the lifecos are trading pretty richly on price-to-book metrics. In relation to their 10-year historical average of 1.5 times, lifeco stocks are trading at 1.6 times. Relative to the banks, they are currently trading at a 12-per-cent premium. We note that we have adjusted historical book values by 15-20 per cent to account for IFRS 17 (with the exception of IAG, where no adjustment has been made). One of the reasons lifeco stocks are trading more richly than bank stocks on a P/B basis is simply that bank stocks have corrected more severely in anticipation of a recession. Whereas lifeco P/B multiples are only off 4 per cent from their 2022 highs, bank stocks are off 30 per cent. According to our methodology, the latter correction implies a 75-per-cent chance of a recession. Granted, bank earning streams are more linked to economic cycles, but at the very least, we can argue that downside risk associated with a downturn has been more clearly reflected in their multiples.”
Mr. Dechaine’s target changes are:
- Great-West Lifeco Inc. (GWO-T, “sector perform”) to $42 from $40. The average on the Street is $42.75.
- IA Financial Corp. Inc. (IAG-T, “outperform”) to $104 from $100. Average: $100.13.
- Manulife Financial Corp. (MFC-T, “sector perform”) to $29 from $28. Average: $30.33.
- Sun Life Financial Inc. (SLF-T, “sector perform”) to $72 from $71. Average: $73.75.
- Sagicor Financial Company Ltd. (SFC-T, “outperform”) to $8 from $7. Average: $8.83.
Elsewhere, Evercore ISI’s Thomas Gallagher raised his targets for Sun Life to $78 from $76 with an “outperform” recommendation and Manulife to $30 from $26 with an “in line” rating.