On The Dip, MetLife Deserves A Closer Look

| About: MetLife, Inc. (MET)


Should the Financials “losers” of last week be given a second chance?

Large-cap financials companies take a small-step forward: $97 million gained in market value.

Is MET an ideal candidate to buy on the dip?

Welcome to the Financials sector's fifth edition of "Buy on Weakness?", a series of articles that sifts through the underperformers of the week to find potential investment opportunities in the large-cap Financials world.

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Credit: DM Martins Research montage using company logos

The idea is to help investors, particularly those focused on value plays, unearth ideas for the coming week.

The table below highlights the top 20 Financials companies - worth $10 billion or more in total equity value - that have performed the poorest in the previous five trading days.

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Source: DM Martins Research, using market data compiled from Fidelity

Financials returns were flat over the past week

In what was a relatively unchanged week for the financials sector, $97 million in market value was gained over the past week.

Let's take a closer look at some metrics.

Diving deeper into the data

These top 20 financials losers have a relatively high median forward P/E of 17.3x, compared to the S&P 500's median trailing P/E of 14.6x and the overall financials sector's 15.8x. This week's top 20 group is expected to grow EPS in 2017 by 10.5%, and the companies generate a low median dividend yield of 2.2% (16 of the 20 companies are dividend-payers).

The table below highlights, in green font, the three best-positioned financials companies in each of the following categories: projected EPS growth, dividend yield, forward P/E and forward PEG (P/E divided by percentage-point EPS growth).

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Source: DM Martins Research, using data from Yahoo Finance, Nasdaq and Market Watch

So which short-term loser should investors consider adding to their portfolio to take advantage, in the long run, of this price decline? And which should they avoid, despite the price drops?

Let's take a closer look at a featured name on the financials top 20 "biggest loser" list.

MetLife: A compelling opportunity to buy a blue-chip company at a discount.

This week, we look at Metlife (NYSE:MET). The stock, down 4.5% last week, has depreciated by 13% in 2016. Shares have particularly endured a volatile ride during the past 3-month as the stock fell by 17% the day after the June 23rd "Brexit" vote and recently depreciated by 10% after Thursday's 2Q16 earnings.

New York-based MetLife is the largest life insurer in the U.S. and provides employee benefits, annuities and asset management products worldwide in addition to its core life insurance business. The firm is highly concentrated in the U.S. as only 15% of revenue originates internationally.

On Thursday, the company released 2Q16 earnings of $0.83 per share which significantly missed projections of $1.35 per share. Additionally, year over year revenue fell by 6% to $15.24 billion.

The company pledged to cut expenses by $1 Billion by the end of 2019. CEO Steve Kandarian stated: "We know this will require us to reduce headcount, which is never an easy step for an organization to take. Our overall goal is to be more efficient, so that we can better serve our customers and provide a fair return to shareholders."

However, the elephant in the room is the high-profile status of MET's SIFI (Systemically Important Financial Institution designation). The Financial Stability Oversight Council (FSOC) branded MetLife as a SIFI in September 2014 which exposed the company to greater regulatory costs and capital requirements. In January 2015, MetLife challenged the designation in federal court and the label was rescinded on March 30th. The FOSC has appealed the ruling to the D.C. circuit of appeals. MetLife claims that the FSOC never considered the attendant costs to the company that increased regulation would bring while also failing to sufficiently explain how MetLife was a threat to the financial stability of the U.S. The FSOC has countered that it does not need to consider attendant costs and used a thorough analysis to support its SIFI designation.

The company is also downsizing in response to these regulatory pressures as MetLife recently announced that it will spin-off its U.S. retail business as "Brighthouse Financial".

- The bull case: Renaissance Research is a cautious bull that believes MET is undervalued relative to its peers. The author focuses on the plans to downsize the company by separating its lower-returning U.S. Retail business. Renaissance believes that a leaner MetLife will benefit from a higher ROE and lower cost-of-capital since the performance of the US Retail business had been slumping.

The author mentions the headwinds surrounding the pending SIFI appeals decision and explains that an upholding of the prior ruling would free the company from the higher capital requirements to engage in more aggressive share buybacks. Renaissance also notes that the company is emphasizing an "Aggressive Value" initiative by focusing on higher IRR products with more predictable cash flows and believes that investors will reward the company for these efforts.

We do not share the author's enthusiasm for this initiative in the short term and question how much additional revenue can be created from today's low interest rate environment.

Renaissance Research's concludes: "We believe greater clarity on a SIFI status along with the resumption of share buybacks and "Accelerating Value" initiative should support the company's earnings. Hence, we think the current stock prices offer an attractive risk-reward ratio."

Despite our caution and understanding the risks, we believe that now is a good time to buy MET on the dip. By analyzing it against its peers below, MET offers a favorable dividend yield of 3.9% and forward PEG ratio of 0.6. The firm is also undervalued when compared to its closest domestic competitor, AIG.

However, the biggest idiosyncratic consideration is whether or not the SIFI ruling will be upheld. Our view is that the Kandarian's move to spin-off the U.S. Retail business will make a reinstatement of the SIFI designation difficult to justify by the appeals court. Decreased regulatory costs and capital requirements will benefit the company and its investors. Additionally, the improving U.S. labor market should allow for an increase in interest rates over the next 12-months, which will allow MetLife to increase its fixed income investment income.

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Source: DM Martins Research, using data from Yahoo Finance and Market Watch

- The bear case: SA Contributor Ezra Weener recommends exiting the stock in the short-term despite favoring the company's long-term prospects. The author explains that prolonged low interest rates and a flattened yield curve have hurt MET's ability to earn money through the life insurance industry's traditional model of investing in fixed income securities. As a result, Mr. Weener stated that the company's 2Q16 earnings expectations were too aggressive, which Thursday's earnings announcement confirmed.

The author notes the positive long term trends affecting the company: the shedding of the SIFI designation, a future rise in interest rates and increasing customer life expectancy. However, the author's analysis assumes that the SIFI ruling will not be overturned and neglects to mention a future scenario where it is.

Mr. Weener concludes that "MetLife's earnings have lowered significantly in comparison to its stock price. Maybe there is some forward hope that everyone is relying on? I believe there is. However, it won't manifest as early as we hope."

Research report authored by Aris Tindianos and Daniel Martins.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: Research report authored by Aris Tindianos and Daniel Martins