Sun Life Financial Inc. (NYSE:SLF) is a buy today given their diverse asset mix, a rising interest rate environment, proven execution by management, and cost improvement in digital client outcomes. SLF is a Canadian insurance and financial services company, with operations globally in 25 countries. The company's core competencies include insurance sales and wealth management offerings. SLF has over $1.4T in AUM (all figures in CAD unless otherwise noted) and includes business segments divided by geography, notably Canada, U.S., Asia. They also define key business segments in Asset Management and Corporate.
In Canada, the company provides health and life insurance, along with wealth management services, while in the U.S., SLF offers group insurance services. In Asia, SLF defines key business units through both local markets and trans-border offerings. The local market piece focuses on life and health insurance within country borders along with wealth and asset management solutions. Across country lines within the APAC region, SLF also provides wealth management solutions and insurance opportunities. SLF has two asset management subsidiaries; MFS and SLC Management. MFS provides asset management solutions, while SLC Management, an institutional management business, presents alternative investment opportunities led by professionals. SLF is the also only Canadian insurance company among the most 100 sustainable corporations in the world.
The company’s sales mix is very diverse and can thrive in a high-rate environment. Their life insurance segment, similar to competitors, is poised to succeed as the Bank of Canada continues to forecast higher rates. On April 21, at an industry conference, the bank head noted that he’s “not going to rule anything out” regarding a super-sized rate hike of 75 basis points. Historically, the top 10 largest insurers in Canada have succeeded when the 10-year rate has risen, as evidenced below. SLF has 99% of their reinvested policyholder premiums in investment grade bonds, ensuring safety while the gap between premiums and treasuries increase in the short-term. Given this global operating segment comprises of 55% of operating income, SLF is poised to continue to succeed in their core competency.
Sun Life’s key competitors include Prudential plc (PUK), Manulife Financial (MFC) and Aflac Inc. (AFL). While these competitors also operate globally, SLF is better positioned for growth due to their operating efficiency and APAC focus. SLF has 2nd best gross profit as a percentage of revenue, which proves they extract more value than competitors. SLF also has the highest revenue per share, which is a key metric regarding capital structure; this allows the company to have a larger impact during stock buybacks.
SLF is focused on APAC growth, which is growing faster than developed nations. SLF also has stronger brand awareness than competitors, evidenced by its longstanding operations in the Philippines and Hong Kong for over 100 years, which them to quickly penetrate and grow in local APAC markets. This is evidenced notably in Vietnam, where they moved from 13th to 6th in insurance sales from 2020 to 2021 and continue to improve. They also recently expanded a key distribution agreement in Indonesia, which proves the region remains an area of focus.
SLF’s asset management business continues to grow, and the company quietly increased net income guidance for SLC, one of its wholly owned asset management subsidiaries, from $225M to $235M by 2025. While not a large increase, SLF believes its fee-driven asset management business is well primed for value creation. SLC continues to receive high praise from employees given its rating as a 2021 top place to work, and clients seem to appreciate the service, as inflows rose >$32B in 2021.
Recently, their competitor Brookfield Asset Management announced the potential to spin off its fee-earning business at a 25-40x multiple depending on demand. If SLF can deliver on increasing growth in asset management, this segment can generate more income than the market anticipates in the medium term. Meanwhile, their U.S. mutual fund offering, MFS, continues to shine, with 96% of their funds ranking in the top half of 5-year Morningstar historical performance. This asset management arm also achieved 43%, a 2% improvement from 2020, as an operating profit ratio in 2021, as streamlining digital client service started to pay dividends.
The key risks to being an insurer right now include interest rate risks and COVID-19. While interest rates continue to rise globally, historically rates have been trending down and SLF has been negatively impacted. Their risk team evaluates credit spread risk and notes that rate hikes don’t positively impact earnings as much as rate drops negatively affect the business. While the company does hedge their policies in investment grade bonds, there is still downside to rapidly dropping rates.
The second large impact is the potential of global COVID-death increases that affect premium payouts. Global payouts rose to $5.5B in 2021 from $3.5B a year earlier, and two countries where SLF has significant business (U.S. & India) were the top drivers of these payout increases. SLF is diversifying its life insurance business by focusing its growth on smaller markets they have not had a large presence in, like Vietnam and Malaysia. However, by sheer size, U.S. and India are more profitable, so playing catch up in other smaller locales cannot mitigate this risk. Fortunately, the company holds a LICAT ratio of 143%, well above the regulator minimum of 90%, so they have sufficient capital available for use. SLF's dividend yield and consistency is strong compared to peers and they have re-paid shareholders for more than 20 straight years. That said, execution risk cannot be fully accounted for.
SLF recently provided their FY2021 results and forecasts for the coming year. They reported over $1B in Q4 net income and provided a clear plan to increase earnings at an 8-10% annual pace, slightly below their previous 5-year earnings growth rate of 10%. With rates set to increase among all countries were SLF does business, I believe this management projection is a case of “under promising and over delivering”.
SLF has also increased the amount of digitally processed claims, which has reduced over-head. In Q4, 93% of consumer insurance applications, 83% of consumer wealth transactions, and 96% of group health and dental claims were processed online. Their focus on digital outcomes have continued to bear fruit, with selling and general admin expenses increasing just 23% vs. revenue increases of 39% over the past 3 full years. SLF is committed to improving customer satisfaction through online service, and recently committed an additional $48M to Dialogue Health Technologies Inc., a digital operations leader that powers their internal Lumino Health Virtual Care platform.
The forecasted target share price was modeled using price to earnings, given the complexity of its various operating segments. Historically, SLF has had a P/E of ~10, slightly above its peers given its large scale and proven track record. With interest rates primed to increase and management’s confidence in achieving strong growth, I see the 2023 P/E multiple expanding to 11 in the near future.
I forecast revenue growing at 5% and anticipate cost mitigation as the key driver in increasing earnings by 8%+, per company forecasts. Payout costs are likely to eventually decrease to historical levels given above average payouts for COVID deaths. While payout amounts were 90% of revenue in 2020, they dropped sharply in 2021 as SLF better adjusted their premiums and insurance offerings to match updated death forecasting. I see payouts slightly rising this year to 60% of revenues as COVID uncertainty remains, especially in under-developed regions, before subsiding the next year. With Asian digital claims increasing 7% year over year, and improvement in digital client outcomes, SG&A expenses should fall by 2% vs. revenue over the next five years.
SLF has continuously delivered outsized earnings growth and continues to extract value globally, for example recently through the recent IPO of their India asset management joint venture, which generated a $362 million gain. Given SLF’s leading position in individual and group retirement service insurance, I see their multiple expanding (along with their peers) as they continue to penetrate the high growth APAC region. SLF also has a strong dividend yield of 4% at today’s share price of $66 ($51 USD). With a current and target payout ratio of 40%, this yield is safe.
Based on 2023 estimated earnings per share of $7.10, a 11x multiple provides a share price projection of $77 ($60 USD). Combined with the current yield, this stock has a total potential return of 20% in 18 months.
SLF is a buy today, given global rate hike tailwinds and revenue acceleration in APAC, a high growth region. I believe that as interest rates rise, SLF will be able to achieve a higher price to earnings ratio and maintain its leadership among its peers. Given the leadership's proven execution globally and well-capitalized structure, SLF should succeed in the latter half of 2022 and into 2023. The company's continuous improvement in cost management by improving their digital client offerings is exciting and their consistent dividend provides a safe income stream for investors. I believe management will hit the majority of their internal guidance and the stock price will follow within 18 months to a price of $77 a share ($60 USD).
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in SLF over the next 72 hours. 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.