ING U.S. Is Still Unloved, Underappreciated And Undervalued

| About: Voya Financial, (VOYA)

In July of this year, I wrote about an attractively priced spin-off called ING US Inc. (NYSE:VOYA). As the stock market has continued to rise, it has been much more difficult to find attractive opportunities, so buying a business with an approximate net asset value of $40 for $30 makes a lot of sense. It is even better when there is a high likelihood that the company's net asset value should be able to compound adjusted for dividends by approximately 10% per annum over the next five years. VOYA is a retirement and investment management specialist that trades at a discount due to the perception of it as a life insurance business. The company has hedged its exposure to volatile equity markets on its legacy variable annuities business, and now can focus on boosting margins, growth and capital efficiency on its ongoing operations. For investors, I believe VOYA offers the opportunity for low to mid-teens per annum appreciation from current levels.

VOYA provides retirement, insurance and investment solutions to its approximately 13MM individual and institutional customers. The company has over 200,000 points of distribution and is the 2nd largest provider of defined contribution retirement plans in the United States based on the number of plans, and is in the top five in both term life insurance and medical stop loss coverage. These aren't sexy businesses and similar to other companies with exposure to legacy annuities businesses, VOYA was hammered by the Financial Crisis and the low interest rate environment that followed, due largely to guaranteed interest rates that were too high when adjusted for risk. As a result of these issues, VOYA has essentially walled-off this exposure, but the result is extremely volatile GAAP earnings. Most analysts and market participants in my opinion, over-emphasize the importance of GAAP earnings, in relation to net asset value, which I believe to be a better gage of the future earnings power of an enterprise. VOYA's short-term earnings reports will be messy and confusing, which is further complicated by the fact that the company was recently spun-off from ING (NYSE:ING), so there is an opportunity to benefit from a time and value arbitrage between now and when the earnings picture will clear up around 2015.

On August 7th, VOYA reported reasonably strong financial results for the 2nd quarter. After-tax operating earnings of $177M, or $0.71 per share, were up from $129MM, or $0.56 per share in 2012. The GAAP net loss available to common shareholders was $82MM, or $0.33 per share, down from net income of $634MM, or $2.76 per share in 2012. The loss was driven by a $220MM after-tax loss, including an after-tax loss of $79MM related to nonperformance risk in the Closed Block Variable Annuity (CBVA) segment. The CBVA hedging program's focus is on protecting regulatory and rating agency capital from market fluctuations, as opposed to minimizing GAAP earnings volatility, which is a business philosophy that I believe makes a lot of sense. Maintaining adequate capital and credit ratings is much more important for the long-term health of insurance company that short-term GAAP earnings. The hedging program is designed to experience a loss when the equity market appreciates and to gain when the equity market depreciates.

VOYA's Ongoing Business consists of the Retirement, Annuities, Investment Management, Individual Life, and Employee Benefits segments. The Corporate, CBVA, Closed block Institutional Spread Products and Closed block Other segments are not reflected in Ongoing Business results. Operating earnings for the Ongoing Business before income taxes were $307MM, up from $192MM the prior year. Adjusted operating earnings for the Ongoing Business in the quarter were $303MM, up from $279MM in the year ago period. Over the first half of the 2013, VOYA achieved $581MM in pretax adjusted operating earnings, and 75% of these earnings came from retirement solutions and investment management, which are higher growth and less capital-intensive businesses. The annualized adjusted return on equity for the Ongoing Business was 9.9% for the first half of 2013, compared with 8.3% for FY 12. Importantly for future business results, total assets under management and administration grew 5% YoY to $482 billion, supported by net flows in the Retirement and Investment Management segments of $442MM and $3.1 billion, respectively. VOYA is in the process of re-positioning its Individual Life business with a focus on less-capital intensive produces, while also expanding its Employee Benefits product portfolio. Insurance solutions only contributed 25% of the earnings for the first half of 2013.

The company's first half adjusted ROE of 9.9% is 160 basis points better than year-end 2012 and the company is committed to a goal of 110 basis points of annual improvement over the next several years. VOYA believes it is well on its way to at least a 12-13% ROE by 2016 and I wouldn't be surprised to see the company reach the goal a little bit earlier. To achieve its goals, the company is focused on three primary initiatives pertaining to margins, growth and capital. Importantly, the company has designated individuals in charge of achieving these goals and is regularly measuring to ensure that the company is on track. Total return on capital improved 110 basis points to 8.3% in the first half of 2013 from 7.2% in 2012, and the target is to reach a return on capital of 10% to 11% by 2016. Increasing interest rates should help the return on capital and return on equity metrics due largely to increased investment yields.

The Retirement segment improved its return on capital by 190 basis points to an annualized 9.1% in the 1st half, up from 7.2% over the 1st half of 2012. These results were achieved through maintaining pricing discipline by reducing the guaranteed minimum interest rates, which is imperative to generating adequate internal rates of return in this low interest rate environment. The Annuities business improved its return on capital to an annualized 7% in the 1st half of 2013, which was up from 5.9% in 2012. VOYA is running off multi-year guarantee annuities and is concentrated on growing its mutual fund IRA custodial products called Select Advantage to improve IRRs. The Select Advantage program provides clients with a large amount of mutual fund options, including proprietary funds, with very low transfer fees. Investment Management achieved an operating margin of 25.4% in the 1st half of the year, which was up from 24.6% in the 1st half of 2012. The segment is targeting an operating margin of 30% to 34% by 2016, which is exceptionally high for the industry. Individual Life is the laggard segment, posting an annualized return on equity of only 4.5% in the 1st half of 2013. Employee Benefits return on capital was 16.8% in the first half of 2013, down slightly from 16.9% in the 1st half of 2012, and the company's goal is to reach 18% to 22% by 2016.

Like other financial institutions, VOYA's balance sheet was adversely impacted by the sharp increase in interest rates, which caused Other Comprehensive Income (OCI) to drop by $1.4 billion during the 2nd quarter. At the end of the 2nd quarter, Total ING U.S. Inc. Shareholders' Equity-Excluding AOCI stood at $10.3838 billion, or $39.82 per share. The debt to capital ratio at the end of the 2nd quarter was 25.4%, which is in line with the company's goal to operate in the 25% area. The risk-based capital ratio stands at 454%, which is above the company's target of 425%. This equates to excess capital of about $400MM and the company is planning on generating excess capital between $1.2 billion and $1.4 billion up to 2016, which should set the stage for a strong stock buyback program. Obviously, stock buybacks done at such a significant discount to net asset value would be highly accretive to shareholders'.

Based on 260.8MM shares outstanding and a recent price of $30.27, VOYA has a market capitalization of roughly $7.894 billion, which is 73% of book value, excluding AOCI. Including AOCI, total ING US. Inc. shareholders' equity stood at $12.471.6 billion at the end of the quarter, or $47.82 per share. Buying the stock at such a steep discount to book value provides a reasonable margin of safety, but fortunately for shareholders', I fully expect the net asset value to grow over the next five years. Determining the rate of return is difficult because there are a lot of variables, not the least of which are future interest rates. The below table shows the current net asset value excluding OCI and shows the compounded returns at 8%, 10% and 13%.

As you can see, even on the low end of our dividend-adjusted model of 8% compounded growth, VOYA's net asset value in year 5 would be approximately $58.51, which is nearly double the current price. Since the company is likely to generate quite a bit of excess capital setting the stage for accretive stock buybacks, I believe that growth should exceed 10% over this time period. VOYA might not have the allure of a Tesla (NASDAQ:TSLA) or Netflix (NASDAQ:NFLX), nor does it have the institutional ownership of an AIG (NYSE:AIG), but for long-term investors there is a real opportunity to double your money over the next five years without too much risk. As usual, dollar-cost-averaging is highly recommended because there will likely be considerable volatility.

Disclosure: I am long VOYA, AIG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.