My contrarian instincts have been awakened by the recent sell-off in Manulife Financial’s (MFC) shares. After announcing on Aug. 5 a much bigger-than-expected $2.4 billion loss in the second quarter, the life insurer’s shares are down to $12.70 Tuesday, a decline of about 20% over the past 2 weeks.
Investors are becoming quite disgruntled with the steady stream of negative surprises. Over the past year, the dividend has been chopped in half and there has been major dilution of shareholders thanks to several equity offerings that raked in billions of dollars. Share prices are down by about half over the year.
If Manulife had been reporting in U.S. dollars under U.S. accounting standards, it would have actually reported a small increase in earnings in the second quarter, instead of a whopping big loss. That’s because the U.S. doesn’t have mark-to-market rules.
But Canada does. So Manulife had to set aside reserves to cover possible claims arising from the unhedged segregated-fund and variable-annuity products sold to customers (they guarantee against stock market losses and stock markets have declined recently). Also, the decline in interest rates required setting aside reserves to cover drops in the value of the insurer’s bond portfolio.
This should not be a permanent setback. Whenever stock markets and interest rates go back up, Manulife will be able to release these reserves back into earnings. So it would seem tempting to nibble on some shares, especially considering:
- fortified balance sheet
- dividend yielding over 4%
- trading below book value
- growth profile in Asia
- capital ratio of 220% (above regulatory requirement of 150%)
Yet, the potential for bad news remains. If markets and interest rates swoon some more, the shares could tank further. The CEO has said he would engage in asset sales rather than cut the dividend or issue more equity. But confidence is low in management at this stage.
The market also didn’t like the rather large drop in the capital ratio in the second quarter. At 220%, it is still well above minimum requirements, but had previously been 250%.
Another concern is Manulife’s shift in business strategy, which could lead to further pressure on earnings. The company is revamping its product mix to reduce equity and interest-rate exposure. This means they are slowing down sales of some of their biggest businesses, notably segregated funds and variable annuities, to focus more on their Asian business and fee-based products such as mutual funds.
Last, the Office of the Superintendent of Financial Institutions is carrying out a review of capital requirements for segregated funds and variable annuities. The OFSI recently said that it expects the new capital requirements will come into force for sales of products in 2011 and afterward. As the provisions will more likely increase than decrease, Manulife could see higher costs, reduced capital ratios and/or shrinkage in the volume of business in this area.
Thus, my contrarian instincts are piqued but not yet to the point of clicking on the buy button. Nevertheless, I have the company on the watch list and will continue to mull things over. Investors with lower requirements for a margin of safety might perhaps succumb to the temptation.