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Shares of MetLife (MET) have been off to a very strong start in 2013. Investors saw a 9.1% return in the first three trading days of the year alone. The insurance company benefited from a fiscal cliff solution and an uptick in long term interest rates.

Strong Start To The Year

Like any other company, and financial firms in particular, MetLife benefited from the resolution of the fiscal cliff. Shares of the largest life insurer of the nation furthermore showed impressive gains as an uptick in higher bond yields improve earnings on its almost $400 billion fixed-income bond portfolio.

The fiscal cliff resolution, the strong job numbers and the fact that the Federal Reserve might end their combined $85 billion in bond purchases this year, sent Treasuries lower over the past week. 10-year interest rates inched up by more than 25 basis points, almost touching upon the 2% mark. Higher interest rates simply means higher reinvestment opportunities, benefiting MetLife's bottom line.

As there are more signs indicating that the economy continues its recovery, many fixed income investors wonder if bond yields have more room to the upside as the economic recovery continues.

2013 Outlook

In December, MetLife warned the market that low interest rates continue to have an effect on the business, as the effect of low reinvestment rates becomes more apparent. The overall portfolio yield is expected to fall by 30 basis points to 5.27% in the coming year.

Despite the low interest rate environment, MetLife expects it can grow its earnings in the coming years. The company guides for operating earnings of $5.5 to $6.0 billion in 2013, which translates into earnings per share of $4.95 to $5.35. The earnings target implies that return on equity in 2013 will come in between 10.2 and 10.9%, well below the long term target of 12.0-14.0% in 2016.

Valuation

After this week's rally, the market values MetLife at roughly $39.2 billion. This values the firm at roughly 0.62 times the book value of $58.35 per share at the end of the third quarter.

The company guides for full year revenues of $47.3-$47.7 billion for 2012. The company is expected to earn around $5.5 billion, or between $5.15 and $5.25 per share for the year.

At current prices, the market values MetLife at 0.8 times annual revenues and roughly 7 times annual earnings.

MetLife pays a quarterly dividend of $0.185 per share, for an annual dividend yield of roughly 2.1%.

Some Historical Perspective

Shares of MetLife have moved in a fairly wide trading range last year. At the start of 2012, shares were trading around the $30 mark and quickly rose to $39 during spring. Shares fell back to levels in the high twenties in the summer on worries about economic growth and record low interest rates. Shares recovered from that point in time and the strong performance over the past week send shares to $36 at the moment.

Shares of MetLife peaked around $70 back in 2007 and have lost roughly half their value from that point in time. Obviously the financial crisis and the consequent low interest rate environment are to blame.

Investment Thesis

MetLife's shareholders are enthusiastic and hope that the jump in Treasury yields is the bode of a more sustainable uptrend in interest rates.

While the jump in interest rates have moved into MetLife's favor, there are more uncertainties which hold the valuation down. The steep discount to the book value of the firm signals that investors are not comfortable with the degree of leverage of the firm. This fear is confirmed by the fact that the company failed the Federal Reserve's stress test last year.

Besides the financial worries, a changing regulatory environment is putting a hold on shares as well. CEO Kandarian wants to deploy excess capital by repurchasing shares, but he is fearful regulators will not let the firm do that, "I don't have total confidence in the ability to buyback shares over the next few years."

Despite an uncertain regulatory environment, MetLife reiterated its long term buyback plans. The company wants to repurchase roughly $8 billion worth of shares in the coming four years. Excluding the dilutive effect of the acquisition of ALICO, net repurchases will come down to $5 billion, or roughly 12% of MetLife's total shares outstanding.

The company already noted before that it expects to be able to increase operating profits despite the low interest rate environment. The recent uptick in rates, should therefore possibly boost 2013s results. Continued increases in efficiency, growth in emerging markets, possible share buybacks, and the uptick in interest rates could all act as drivers to close the gap with the book value of the firm.

Just three weeks ago, I took a look at MetLife's prospects. I concluded at the time that I would stay on the sidelines. While the earnings multiples are still very attractive, I thought that shares would remain under pressure as cash flow generation does not end up with its shareholders as a result of an uncertain regulatory environment.

The uptick in rates came as a pleasant surprise sending shares higher. Today I reiterate my stance. While the company could close a significant portion of the discount to its book value in the long run, I do not see any further triggers for outperformance at the moment.

Source: MetLife - Uptick In Long-Term Rates Send Shares Higher Into 2013