EUR 850.00 For Business Accounts Only

Morningstar | Top Holding Great-West Powers Earnings Growth at Power Financial; Higher Overhead Prunes FVE

No-moat Power Financial closed the books on a mixed 2018, with strong top-line growth at Great-West offset by lower growth at IGM Financial and Pargesa and higher corporate expenses. Overall, annual adjusted net earnings were up 6.9% to CAD 2.28 billion from CAD 2.14 billion in 2017. On a quarterly basis, net earnings were down nearly 16%. Though this decline is significant and would ordinarily be cause for concern, the drop is mainly from impairment charges related to accounting changes at Pargesa. These charges aren’t expected to recur, and earnings attributable to Pargesa should return to normal levels in the coming quarters. Excluding the impairment, Power experienced a decline in quarterly earnings of about 2%, reflecting the impact of fourth-quarter market volatility at Great-West. Management did not provide any color in the earnings release for the year-over-year increase in corporate expenses of nearly 50%, and we note that these costs directly reduce shareholder returns as compared with individual ownership of Great-West, IGM, and Pargesa. We’re reducing our sum-of-the-parts fair value estimate for Power Financial to CAD 29 per share from CAD 30 after accounting for the higher level of corporate expenses.

No-moat 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 return on equity 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.

There was little in narrow-moat IGM Financial’s fourth-quarter results that would alter our long-term view of the firm. The company 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 assets under management at the end of the fourth quarter, saw a 6.6% sequential and 5.5% year-over-year decrease in its managed assets, affected by 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 exchange-traded fund operations even as it sheds mutual fund and institutional AUM. Investment Planning Counsel, which is IGM Financial's 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. 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 non-bank-affiliated asset managers like IGM Financial to be pressured by increased competition from the Big Six Canadian banks as well as the changing regulatory landscape.