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Morningstar | Manulife Rebounds from Tough Q4, New Business Gains Partially Offset by Continued Outflows

No-moat Manulife had a rebound in the first quarter, with net income of CAD 2 billion, significantly exceeding fourth-quarter earnings of CAD 550 million. Core earnings, which excludes the impact of interest rates and equity market, was up 19% for the quarter and 15% year over year. On the positive side, sales growth in Asia was in the double-digits, new business value expanded across all segments, and the insurer’s expense efficiency ratio decreased 210 basis points to 49.9%. Although net income in the U.S. segment was down 20% on an annual basis and declined for the third straight quarter, this is mostly explained by capital release initiatives and a reduction in legacy business liabilities. We note that U.S. core earnings increased 7% for the quarter, and the remaining core business after completion of the capital release program will be better positioned in the long term. We’re more concerned with ongoing net outflows from the global asset management segment. Given rebounding markets, we were surprised to see negative net U.S. flows of nearly CAD 4 Billion. On the earnings call, management mentioned portfolio rebalancing as a factor driving outflows. This justification was also provided last quarter, and we think results in the coming quarters will provide a good indication of whether these outflows were a one-time event or a sign of a more permanent trend. We don’t detect any changes to Manulife’s underlying fundamentals, and we don't anticipate making a material change to our fair value estimate of CAD 23.

Manulife is on track to meet its goal of releasing $5 billion in capital from its legacy businesses by 2022, with $4 billion in announced initiatives as of the first quarter. Though medium-term targets of 10%-12% core EPS growth and 13% core ROE were achieved in 2018, and thus far in 2019, we would like to see more aggressive targets established by management. Given the current trajectory of the business, we don’t expect Manulife’s ROE to surpass our 11% cost of equity over our forecast period. In addition, management's target for EPS growth seems somewhat conservative given that growth exceeded 13% in each of the last four years. We also note that Manulife remains well capitalized, with a LICAT ratio of 144%, well above the supervisory target of 100%.

As mentioned, high growth in Asia was a bright spot for Manulife in the first quarter. Premium income was up 9% on an annual basis, with core earnings up 16% to CAD 608 million. This growth overshot our expectations, though we believe long-term growth in Asia will stabilize in the upper single digits. Asia is now the largest source of earnings for Manulife and accounts for just over 30% of overall net income. In line with peers, Manulife has suspended sales of corporate-owned life insurance in Japan pending tax law changes. Given the diversity across countries and product offerings, this shouldn’t have a material impact on sales numbers in Asia, but the suspension will certainly be a headwind for growth in Japan, the segment’s largest source of premium income. Manulife also booked an experience gain in Asia in the first quarter, the first time this has occurred since late 2016. We believe this indicates improved underwriting, a positive development in a segment that tends to have volatile results quarter to quarter.

The Central Bank of Canada kept interest rates at 1.75% following its March meeting, holding the benchmark rate stable since its increase from 1.5% in October 2018. In its policy statement, the bank advised that current economic conditions continue to justify a policy interest rate below neutral, and that the slowdown experienced in late-2018 was sharper than anticipated. The 0.4% annualized GDP growth in Canada in the fourth quarter was the slowest level of growth since the mid-2016 recession. The IMF is forecasting 2019 real GDP growth in Canada to reach 1.5%, lower than both the U.S. and all advanced economies, at 2.3% and 1.8% respectively. Continued sluggish growth in the Canadian economy would negatively affect Manulife and could result in lower revenue and curtailed earnings growth.