MetLife: Capitalizing With An Industry Leader
- MetLife increased its dividend by 4.5%, marking its fourth hike in the last four years.
- Brighthouse spinoff proved to be an excellent strategic shift and LTC exposures are capped.
- Investment portfolio is almost entirely investment grade quality and the Fed put helps backstop credit losses.
- Shares sell for 0.55x tangible book value, a decade low multiple.
The coronavirus has hit financial sector earnings as interest rates have been retrenched back to the zero lower-bound, insurance claims have slightly risen, and commercial loan losses have surfaced. However, with the Federal Reserve growing its balance sheet by nearly $3 trillion, or 75% quarter-over-quarter, it has provided an unprecedented willingness to backstop financial markets. The Fed is purchasing U.S. treasuries, MBS, municipal bonds, ABS, commercial paper, and investment grade bonds. If the market cannot price credit risk in these asset classes properly, then the underwriters and intermediaries stand to benefit the most, i.e. financials. Fortunately, investors can take advantage of this ongoing dynamic - consider MetLife (NYSE:MET).
MetLife may not provide an outstanding total return opportunity for investors given the sector is generally out of favor in this low-growth environment, however the company can certainly generate decent returns for investors, while providing a hefty dividend stream along the way.
MetLife has maintained a very strong balance sheet, where A.M. Best and the three rating agencies rated all subsidiaries of MetLife between A+ to AA, falling into the highest tiers of credit quality. In late April, MetLife raised $1 billion in bonds to increase its total cash and liquid assets to more than $5 billion. Despite the ravaging effects of the coronavirus on the broader economy, MetLife has so far brushed it off. Of course, the business has significant macro exposures, so we'll see the extent of the headwinds unfold with first quarter earnings. Fortunately, management decided to preemptively raise the quarterly dividend distribution to $0.46/share, up from $0.44 last quarter. CEO, Michel Khalaf, was happy with the decision: "We are pleased that our financial strength enables us to increase our common stock quarterly dividend, which provides a steady and growing income to millions of people during this economically challenging time." This hike actually runs on the back of three prior dividend increases in the last few years:
At $34, investors capture a dividend yield of 5.4%. Relative to other areas of the market, such as consumer discretionary, services, energy, REITs, etc. which have cut or suspended their dividends, or even have fallen into liquidity crisis scenarios, MetLife has separated itself from the crowd with a dividend increase. To be sure, earnings and ROE growth will likely remain capped, but its strong balance sheet, cost cutting, and healthy credit portfolio will cushion downside.
MetLife has been tapping several channels to maintain U.S. earnings through added deals, strategic partnerships, and M&A, including $1.9 billion in pension plans for Lockheed Martin, a JV deal of $1.8 billion with luxury REIT UDR, and entrance into the pet insurance market via acquisition of PetFirst Healthcare. What's even more exciting is the international opportunity, with Asia showing 13.5% earnings growth year-over-year, while Latin America and EMEA demonstrated low-single-digit earnings growth. And they've managed to exit trouble spots that face secular headwinds, i.e. Brighthouse and long-term care policies.
The Brighthouse Financial (BHF) spin-off was an excellent play by management as they saw the writing on the wall. Annuities and variable life products need relatively higher interest rates in order to achieve earnings growth. BHF's cumulative return on equity has been nil and book value has effectively flat-lined since its IPO. If you want to see a corner case in insurance, then look no further than BHF which lost more than two-thirds of its market value in less than three years, and now carries a price to book value of 0.17x. With MetLife's sale of the BHF common stock, management was able to raise $944 million in cash, eliminating outstanding debt.
Pertaining to long-term care, it's been a problem for all insurers for about a decade. The canary in the coal mine was when Genworth Financial's (GNW) long-term care reserves were woefully understated, resulting in multi-billion dollar impairment charges in 2014 and other hundred million dollar charges in subsequent years. Fortunately, MetLife and Prudential, among others, significantly reduced underwriting of these policies (MetLife eliminated underwriting these policies entirely) due to the high complexity of the contracts (laundry list of sensitives and ever-changing inputs variables), such as mortality, morbidity, payment lapses, interest-rates, etc. versus the capacity of raising of premiums, which must be approved by the states. Fortunately, MetLife only incurred LTC reserve charges to the tune of $79 million and $22 million in 2018 and 2019, respectively. These levels are actually pretty favorable against a book that is as large as $12.5 billion versus Genworth's LTC book of $11+ billion (Genworth underwriting continues with the hope that premiums will eventually outrun the costs). All things considered, MetLife has considerably larger insurance and investment income streams to offset any potential LTC losses, and perhaps MetLife might be able to escape them altogether should it be adhering to more conservative underwriting standards. We'll have to wait and see the effects in the coming quarters and years.
Leading into 2019, management has significantly reduced its expense ratio from 13.3% to 12.6%, mostly leading to incrementally higher profit margins:
MetLife's investment portfolio has also grown substantially over the last year, up an astounding 10%, all the while 95% of the portfolio was sitting within investment grade:
Additionally, MetLife took out about $1 billion in investments from non-investment grade and circulated that back into their investment grade corporate debt pools. To be sure, coronavirus has caused the rating agencies to downgrade non-financial corporate debt issuers, particularly more cyclical names. However, with investment grade credit spreads coming back to earth, I'd argue that MetLife's portfolio is pretty well insulated. Conversely, private equity and hedge funds dabbling in distressed debt (i.e. junk) aren't so lucky as credit spreads are trending near 10-year highs, and many companies are set to file bankruptcy over the remaining course of 2020 and heading into 2021. Insurers, on the other hand, remain significantly less exposed.
Insurance has been a low-growth industry for quite a while, but MetLife is probably among the best choices given its strong balance sheet, friendly capital return policies, and limited downside insurance and credit risk exposures. Today, investors can buy MetLife at a decade-low price to tangible book multiple of 0.55x, while grabbing a dividend yield of 5.4%. At $30, investors would obtain a dividend yield of 6%. Thank you for reading and please comment below.
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