Credit Suisse Research analyst Thomas Gallagher and his team published a report titled “U.S. Life Insurance 2012 Outlook: The Growing importance of ROA” on Dec 19, 2011. The analysts have highlighted upcoming regulatory measures, along with stocks that are expected to outperform. Gallagher argues that many sovereign issues that were previously thought of as risk-free are no longer considered so and as a result of this the importance of ROA is increasing for financial companies. Gallagher expects that capital management and generation of excess capital will be the key themes for life insurers in 2012. Below is a summary of the stocks discussed in the report:
Ameriprise Financial Inc. (AMP) has been included in the top ideas within the U.S. Life Insurance sector by Credit Suisse. Gallagher highlights AMP as the cheapest company under coverage, with just 9x free cash flow compared to MET and PRU which are currently trading in the mid-teens range. The company is expected to generate highest FCF per unit of earnings (over 80%) compared to its peers, primarily due to its favorable business mix geared towards asset management, retail financial advisory and brokerage. The stock is trading at a discount because AMP is not growing its more capital intensive insurance businesses. However, the company stands out compared to other larger financial companies on the basis that they can use 80-90% of its earnings for buybacks and payout dividends to their shareholders. This number is around 60% for large banks and potentially non bank SIFIs.
AFLAC Inc. (AFL) has also been ranked among top ideas by Credit Suisse on the basis of its expected relative performance. Though company’s exposure to Europe would remain highest and concerns related to the Euro region have not disappeared yet. Gallagher thinks AFL to outperform its peers because of its high ROEs and ROAs, its lack of reliance on derivatives, captive reinsurance, or matched funded leverage. Moreover AFL’s high capital efficiency allows it to grow significantly faster than its peers, while at the same time generating a robust level of free cash flow. AFL currently trades at about 10x its capital generation and its FCF is more than 60% of its earnings.
Prudential Financial Inc. (PRU) has been assigned an Outperform rating by the Credit Suisse with a near term bias in favor of the company. PRU is modestly cheaper on free cash flow multiple at about 14x. Prudential’s 2013 valuations are relatively cheaper because of the expectation of higher expected growth rates for the company, which will be supported by growing international and annuity books. PRU also has low exposure to Europe and is less reliant on longer duration derivatives which have some uncertainty regarding onerous requirements expected from Basel III.
MetLife Inc. (MET) has also been assigned an Outperform rating by the Credit Suisse with a near term bias in favor of the company. Key areas of focus for 2012 are “whether the Fed gives MET the green light on its capital management plan during the March/April time frame, which should help improve the valuation of MET”. MET’s strategic review is expected to improve its free cash flow, and reductions in derivatives positions will also act as an additional catalyst. Gallagher estimates statutory operating income of $4B to be generated by MET in 2012.
Lincoln National Corporation (LNC) has been rated Neutral by Gallagher. Stock appears cheap on valuations with below 5x EPS and less than 50% of book value, but looks expensive on statutory free cash flow (about 15x). If LNC manages to free up its redundant life insurance reserves, the free cash flow multiple would drop down to 10x.
Torchmark Corporation (TMK) has been upgraded from Underperform to Neutral by Credit Suisse on the basis of sustainable capital generation by the company backed by its structurally favorable business mix. FCF for the company currently stand at 66% of earnings. Company now maintains high capital efficiency – statutory ROA and ROE of over 3% and 20% respectively. TMK trades at a 2012 PE ratio of 8, slightly above its peer average of around 7. However, TMK’s free cash flow multiple of 11-12 is lower than its peers.