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Morningstar | Manulife Wraps Up Strong 2018 With a Decent Fourth Quarter; Continued Focus on Capital Release

No-moat Manulife capped off a solid 2018 with slightly weaker fourth-quarter results. Though annualized return on equity fell to 5.3% (well below our 11% cost of equity) and net income dropped about 60% sequentially, these declines were primarily due to the impact of equity markets. Stripping out nonrecurring items, earnings were moderately lower across all business segments and down approximately 13% overall from the third quarter. On the positive front, earnings sensitivity to markets and interest rates have declined significantly since the great financial crisis. Geographic diversification allowed Manulife to realize positive net inflows, an impressive feat considering high U.S. outflows. We’re maintaining our CAD 23 fair value estimate and note that we’re not assuming legal exposure from the Moston lawsuit because we think a decision against Manulife is unlikely.

Manulife has continued to make progress on its capital release program, including sales of ALD annuities and reinsurance on legacy businesses, and the firm is on track toward its goal of releasing CAD 5 billion. Over the past two quarters, Manulife has ceded over $8 billion of premiums in its U.S. business, primarily from the sale of Group and Individual Pay-out annuities. We view the sale of these businesses as a positive, given the competitiveness of the U.S. annuity market and lack of a moat in the segment. We believe annuity sales will likely struggle to build momentum in the long term as the sale of annuities often fails to meet the fiduciary standard. While Manulife ended sales of fixed annuities in mid-2018, it’s now the last of the Canadian insurers to maintain a significant annuity presence in the U.S. We think management should consider divesting the remainder of the business to focus on the targeted high-growth segments of wealth management and behavioral insurance, and we are encouraged by its goal of having these segments, along with Asia, account for two thirds of earnings by 2022.

Though U.S. insurance continues to be the largest contributor to core earnings, we expect Asia will likely surpass the U.S. within the next year. We forecast about 10% premium growth for the Asian division by 2022, materially higher than the Canadian and U.S. divisions, at 6% and 3%, respectively. Premium growth is a worthwhile goal; however, we view the potential for growth in the Asian wealth and asset management space with greater interest. Manulife is better positioned than its peers to manage the inherent risks and regulatory challenges of geographic expansion given its 120-year history in Asia.

It is also worth highlighting our opinion on Manulife’s share repurchase program. In 2018, Manulife more than tripled its share repurchase program from the prior year, with a plurality of the buybacks occurring in the fourth quarter. Manulife’s share price took a hit in late-2018 from the disclosure of the Moston lawsuit and shorting by hedge fund Muddy Waters. Since markets appeared to be overreacting to legal risks, we take a positive view of the higher level of repurchases.