Doom and gloomers have a terrible track record with Genworth (NYSE:GNW). A few years ago, these pessimists and short sellers tried to make a case that the mortgage insurance business was going to sink this company for good. That turned out to be completely false and now the mortgage insurance business is strong. If you had bought Genworth during that pessimistic time you could have loaded up on shares for between $2 to $3 and then watch it surge back to over $18 per share by March 1, 2010. By 2012, Genworth shares plunged back to about $5, but once again by March, 2014, it was back to trading for about $18 per share. Now, the shorts and doomsayers have pushed it down to just about $2.50 per share, over fears that the company will never get the long-term care division making money again, even though historically this line of business has been profitable in the past.
Genworth shares were trading for about $5 just last month, and now it trades for about half of that level. That is a major decline in just a few weeks and I think this has spooked some investors into thinking that the company might announce additional charges to add to reserves for the long-term care business. However, I don't think that is the case for a number of reasons. I believe the decline in the stock is not due to a "bogeyman" in the closet but rather can easily be explained by the fact that this stock was hit hard by tax-loss selling in December, and then was hit further like almost every stock in this market, due to a significant market plunge in the first couple weeks of 2016, which took some major indexes down by 12% or more. Financial stocks like Bank of America (NYSE:BAC), Citigroup (NYSE:C) and Genworth have recently been hit even more than most stocks due to concerns that the Federal Reserve's plans to raise rates might not happen as some investors planned just weeks ago. Both Citigroup and Bank of America have lost about 30% in value since December, so it is not that surprising that a small cap company like Genworth would be down even more since smaller company stocks can more easily be manipulated or pushed around by short sellers and also can suffer from less liquidity. I think this common sense analysis easily explains the drop in Genworth shares and therefore should allay fears about the idea that there is something really wrong with the business model for this company. I also think that the sell-off in the financial stocks due to fears that interest rates will not be raised much in 2016, is silly because these companies have been dealing with a low rate environment for nearly a decade. Also, these stocks did not get a big rally when the Fed raised rates by a quarter point, so there should be no big plunge, especially since these companies are still better off now than they were before the rate hike. There are other reasons why I think the stock price decline is way overdone:
In addition to concerns that Genworth might take another charge for the long-term care division, I have heard that some investors are concerned about a big drop in home prices in Australia since it is an oil producer, but home prices have remained strong and default rates are extremely low. If you read three key paragraphs from Genworth's latest conference call, you can get a strong sense that major fears about the mortgage insurance business in Australia, and the long-term care division, appear totally without merit. In fact, Genworth states that the business in Australia continues to be a "solid performer" and that the margins for the long-term care business are in line with their assumptions, and that with major premium increases, financial results could get a major boost. The transcript states:
Regarding Australia, this business continues to be a solid performer with good profitability, returns and capital generation. We expect capital management opportunities in Australia to provide significant cash to the holding company over the next couple of years. At its current valuation, we believe realizing those opportunities is more valuable to Genworth stakeholders than selling more of this business.
Turning to long-term care, we continue to make strong progress in obtaining rate increases to address our legacy LTC blocks and some of the newer blocks. During the quarter, we obtained five additional approvals with an average rate increase of 29% on $9 million of impacted in force premium. Since the end of the third quarter, we have received additional approvals covering approximately $190 million of additional in force premium with an average rate increase of 26%, bringing year-to-date total in force premium impacted close to $700 million with an average rate increase of 29%.
The average premium rate approved and the level of impacted premium achieved through the third quarter of 2015 remains in line with our 2014 ALR margin assumptions. We continue to expect to see a more meaningful benefit to LTC earnings from these actions later in 2016 as the significant increases approved in 2015 are implemented on policy anniversary dates.
As mentioned above, the transcript from the conference call details that recent premium increases averaging about 29% on roughly $700 million in policies will have a meaningful benefit for the company in 2016. A 29% average increase on $700 million in policies represents about an extra $210 million annually, which can go towards the bottom line in 2016, since these rate hikes have recently been approved by various regulators and implemented. Since Genworth has nearly 500 million shares outstanding, a $210 million addition to the bottom line is equivalent to potentially about 42 cents per share in additional profit. Another factor that could boost results in 2016, is the $100 million expense reduction plan that the company announced last year. This could add about 20 cents per share to the bottom line when fully implemented. While shorts and doomsayers may want you to believe that this company is never going to post solid profits just because it posted a loss in 2014, due to the reserve charge it took for long-term care, this company has a history of posting profits. Genworth was profitable in 2011 (even though the economy had not fully recovered from the financial crisis), and it earned 66 cents per share in 2012 and $1.13 per share in 2013. I believe the significant reserve charges Genworth took in 2014 were strategic and it allowed the company to position for significant premium increases which it has subsequently received from state regulators. Instead of being rewarded for this move, and applauding management for being more conservative with its reserves, the market has punished the stock and seems to have cast doubt on management credibility ever since. I think this is the wrong conclusion and that over time, shareholders will be rewarded by these management decisions.
I also think it is worth pointing out that Genworth's bonds do not indicate that this is a company that is in distress or one that deserves to be trading for half of what it was just a few weeks ago. If you want to know what distressed bonds look like, take a look at Chesapeake Energy (NYSE:CHK) bonds and you will see bonds (maturing in the next few years) that are trading for 26 cents on the dollar, 27 cents on the dollar and 33 cents on the dollar. By contrast, Genworth bonds maturing in the next few years are trading for about 80 cents on the dollar, 86 cents on the dollar and even for parity or above. Genworth has a Morningstar credit rating of BBB-. Furthermore, in another sign of financial strength, Genworth recently announced that payed off $300 million of senior bonds for 100% of the principal amount in January, 2016. Companies that are in distress don't often use $300 million to pay off bonds in full, so this is another factor the shorts and doomsayers should consider as another sign that this company is planning to be in business for a very long time.
I am aware that Genworth has challenges to overcome in its business, but absolutely all businesses have competitive threats, risks and challenges. My point is that I believe the challenges Genworth faces are extremely overblown when you consider how cheap the valuation is and the fact that this company has a history of overcoming tougher challenges than it has now. Are Genworth's businesses and the macro economic environment really as bad off now as they were at the depths of the Financial Crisis? I think that question is easy to answer, and yet the stock has been pushed down by tax-loss selling and a market correction as if the world might soon end like it did in 2008-09. I believe there is a real disconnect between Genworth's share price and the true value of its businesses and some analysts agree with this. Just a few days ago, an analyst at BTIG came out with a new report on Genworth and set a $10 price target. This, along with other analyst price targets, all of which are significantly higher than the current share price, suggests that investors are making a big mistake in selling at current levels.
Analysts expect Genworth to earn 96 cents per share in 2016. That seems quite reasonable if you consider that Genworth earned more than that in 2013, and also if you add in the potential increase to earnings that could come from the long-term care premium increases (estimated to add $210 million per year or about 42 cents on a per share basis) as well as the $100 million expense reduction program (estimated to potentially add 20 cents per share to earnings).
I believe Genworth's management team has put in a strategy and plan that the market has yet to appreciate. It took a big charge to boost long-term care reserves and in doing so it did the right thing in order to be more fiscally conservative, and those charges also probably paved the way for this company to proceed with very significant rate increases which will start to positively impact the bottom line in 2016. Now, I believe the company is positioned to report much better financial results in 2016. This should pave the way for the company to boost its financial strength and balance sheet and that will position the company to spin off the mortgage insurance division. If Genworth is able to report some clean quarters with solid profits in 2016 and if those results lead to about $1 per share in earnings, it is reasonable for this stock to be worth $10 per share, as suggested by BTIG. This will be especially true if Genworth is able to separate its business with a spin-off which is something the company has said it is considering. This could become an increasingly popular trend in the insurance industry as Metlife (NYSE:MET) just announced it would move forward with a spin-off.
In summary, the market has a history of being overly negative and mis-pricing Genworth shares and once again this appears to be the case today. This mis-pricing has only been exacerbated by tax-loss selling in December, as well as what appears to be a very irrational stock market correction of about 10% in the first weeks of January. Many stocks are trading at very cheap levels right now, unless you believe the world is coming to an end. Earnings Whispers estimates that Genworth will report 21 cents per share in earnings for the fourth quarter of 2015, on February 4, 2016. I think that this final quarter for 2015 will show a solid operating profit, but it will also have a potential one-time charge from the sale of certain policy blocks it recently sold. This could clear the slate for Genworth to report clean and solid quarterly financials for 2016, and later this year potentially announce the spin-off of its mortgage insurance business. For all these reasons, I see the path from $2.50 per share to BTIG's price target of $10 as being realistic. That might look like a stretch right now but remember, Genworth shares have made bigger moves than this multiple times in the past. Furthermore, the analyst earnings estimates, the analyst price targets, the price of Genworth bonds and the recent $300 million bond payoff all suggest that this stock probably does not deserve to be trading at current levels if it were not for tax-loss selling and a recent market correction. In fact, if you look at the $5 per share this stock was trading at just a few weeks ago, along with historical earnings and the benefits of the significant premium increases, the $10 price target does not seem to be a stretch whatsoever.
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Disclosure: I am/we are long GNW.
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.