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Morningstar | Power Corp Takes Hit From Volatile Markets in 4Q; Shows Evidence of Corporate Cost-Cutting

Earnings growth at no-moat Power Corporation hit a snag in the fourth quarter, with its non-Power Financial holdings experiencing a CAD 20 million loss due to equity market declines. For comparison, these holdings had positive adjusted net earnings of CAD 139 million in the third quarter. For the year, earnings were down over 8%, with the losses of non-Power Financial holdings including Sagard and China AMC mitigated by moderate annual growth at Power Financial. Even still, earnings at Power Financial also took a step back in the fourth quarter because of impairment charges related to accounting changes at Pargesa, another holding company part of Power Financials’ portfolio. These charges aren’t expected to reoccur and earnings attributable to Pargesa should return to more normal levels in the coming quarters. Although corporate expenses decreased 14% year over year, we note that these costs directly reduce shareholder returns as compared with individual ownership of Power Corp’s portfolio companies. In addition to the annual CAD 125 million in corporate expenses at Power Corp, earnings are also negatively affected by its proportion of Power Financials’ corporate costs. We’re maintaining our sum-of-the-parts fair value estimate at CAD 29.

By our estimate, Great-West accounts for about 67% of Power Corp’s total equity value, excluding corporate costs. Great-West’s fourth-quarter results were about in line with our expectations. Though earnings volatility resulting from market challenges had significant effects on surface numbers, this has little impact on the core business. The company continued to create value by posting an adjusted ROE of 14.3%, a year-over-year improvement of 1.1%, excluding effects of tax reform, and we highlight our positive view of Great-West’s decision to sell its U.S. life and annuity business. Looking at the top-line numbers, revenue came in below our expectations, with the biggest decline coming on the investment front. Overall declines were mostly explained by market challenges. However, on balance, the bottom line was relatively unaffected, as mark-to-market investments were netted out by declines in liabilities. For the year, Great-West had healthy premium growth of about 5% and benefits as a percentage of net premiums were lower. Net income was up CAD 700 million for the year, comparing well with our initial forecast. While insurers can use accounting tools to smooth profitability, we view existing assumptions as reasonable and continue to believe Great-West is an adept underwriter.

By our estimate, IGM Financial accounts for about 16% of Power Corp’s total equity value, excluding corporate costs. IGM closed out 2018 with CAD 149.1 billion in managed assets, down 6.7% sequentially and 4.8% on a year-over-year basis. Investors Group, which accounted for 56% of the firm's AUM at the end of the fourth quarter, saw a 6.6% sequential and 5.5% year-over-year decrease in its managed assets, impacted by both market losses and its third consecutive quarter of outflows. Mackenzie Investments, which accounted for 41% of AUM, recorded a 6.7% sequential and 3.7% year-over-year decline in its managed assets, with the firm continuing to generate positive flows from its ETF operations even as it sheds mutual fund and institutional AUM. Investment Planning Counsel, which is IGM Financials’ smallest segment, reported a 7.4% sequential and 4.7% decrease in its managed assets during the period. While average AUM was down just 0.8% year over year during the fourth quarter, management fee income declined 3.3% when compared with the prior year's period, due primarily to ongoing fee compression. Total revenue was down 1.9%, though, during the period, as an uptick in net investment income and other revenue slightly offset lower levels of management, administration, and distribution fees. Full-year top-line growth of 3.0% was in line with our forecast for low- to mid-single-digit revenue growth for all of 2018. As for profitability, while IGM Financial has had a difficult time keeping expenses from growing faster than revenue, full-year adjusted pretax operating margins of 31.1% were up 20 basis points year over year, in line with our projections for 2018. Our long-term forecast continues to call for pretax margins for the nonbank affiliated asset managers like IGM Financial to be pressured by increased competition from the Big 6 Canadian banks as well as the changing regulatory landscape.