Stock Report

Manulife Financial (MFC, Toronto and New York)
RESEARCH SUMMARY
Report Author(s):	InvestorsFriend Inc. Analyst(s)
Author(s)' disclosure of share ownership:	Author(s) hold shares
Based on financials from:	Dec '07 Y.E. +Q2 '08
Last updated:	23-Sep-08
Share Price At Date of Last Update:	$37.50
Currency:	Canadian $
Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not a recommendation and is not Investment Advice ):	Weak Buy / Hold rated at $37.50
DESCRIPTION OF BUSINESS: This is a huge financial services company with an equity market value that was recently around $57 billion. Total assets are a huge $180 billion and there is a further $176 billion of customer assets under management. Its "products" are Life Insurance, Group Benefit Plans and Investment Management. Has significant operations in Canada, U. S. and Asia (Hong Kong, Philippines, Singapore, Indonesia, Taiwan, Japan, Vietnam and China). Only about 25% of operations are in Canada. Operates in 19 countries and territories world wide.
SUMMARY AND RATING: The graph illustrates that the company appears to perhaps qualify as a "great company" in terms of very steady and reasonably strong EPS growth, although revenue per share growth is modest and note we have only eight years graphed. The steady growth in earnings per share is actually not something we would expect from this company and we expect this to be much more volatile in future. The Value Ratios on the face of it indicate a Buy rating but with the actuarial nature of earnings and with the volatile stock markets, and volatile market interest rates, we can't be at all sure that the earnings and past growth are sustainable. Does reasonably well on the Buffett tenets (except clearly not at all simple to understand but its large and "sticky" customer base is a huge plus along with an opaque product where price comparisons are not easy and does well on the Porter analysis of industry attractiveness. We suspect it may be vulnerable to write-offs related to financial assets on its balance sheet. We are amazed at the steady earnings growth (until 2008) despite the higher Canadian dollar and lower interest rates. The insider trading signal is moderately. This has truly been a world-class Canadian corporation which has performed beyond expectations. Growth has been truly exceptional given its already huge size but some of its product lines were flat or down recently (although some products had stunning growth). The accounting disclosure seems detailed but somehow not user friendly. Management appears to be exceptional. On the face of it we could rate this a Buy, but we are bothered by the complexity and risks, the actuarial nature of it and the current vulnerability to asset write downs. Overall, placing weight on the fact that Q3 could be a rather bad quarter, we rate this stock a Weak Buy / Hold but would consider buying under $32.
RISKS: A full analysis of risks is well beyond the scope of this report. Earnings are dependent on stock market performance of investments to some degree. Earnings are also very much subject to actuarial estimates. In fact this company is potentially susceptible to ENRON-like surprises since the balance sheet is largely based on actuarial estimates. However ENRON like surprises are not that likely due to insurance company financial regulations. In fact, the company appears to be indicating that the balance sheet is conservatively stated. The way the earnings have trended up so smoothly, in Canadian dollars, seems almost too good to be true given so much of the revenue is earned in U.S. dollars and given the increase in the Canadian dollars and the decrease in interest rates over the past six years. But we have no indication that earnings are being improperly smoothed...
INSIDER TRADING / INSIDER HOLDING: Checking from April 1, 2008 through Sept. 21, 2008, there is a clear pattern of about 7 insiders exercising options and then selling all the acquired shares. This is not unusual but is nevertheless a moderately negative signal. Notably the CEO is included which we consider negative. There is an incredibly lengthy list of insiders with most owning tens of thousands of shares and options and most of these were not selling in the period checked. Many insiders own a few thousand shares and also own options and a number of insiders own over 10,000 shares. The CEO now owns 513,000 shares plus 6.1 million options, the CFO recently owned 36,000 shares plus 826,000 options. This share ownership should be motivational. Overall the insider trading signal seems somewhat negative at this time but the insider holding is a positive indicator.
WARREN BUFFETT's CRITERIA: Buffett indicates that all investments must pass four key tests: the business is simple to understand (fail because of huge complexity and actuarial nature), has favorable long-term economics due to cost advantages or superior brand power (pass due to sticky customers and opaque product and scale and AAA credit trading), apparently able and trustworthy management (pass although disclosure could be more user friendly), a sensible price - below its intrinsic value (pass), Other criteria that have been attributed to Buffett include: a low debt ratio (pass), good recent profit history (pass) little chance of permanent loss of the investors capital (pass) a low level of maintenance type capital spending required to maintain existing operations excluding growth (pass)
MOST RECENT EARNINGS AND SALES TREND: Earnings per share rose 11% in 2007. Earnings per share in Q4 rose by a huge 25%. Overall the earnings and sales trend looks very positive. However, we worry about the extent of unusual items and smoothing in these earnings. Revenue per share grew by "only" 7% in 2007 and have significantly lagged earnings growth over the past few years and this calls into question the sustainability of the earnings growth. Growth in revenues continues to be reasonably strong in 2008 but with some areas of the business slowing somewhat. Earnings per share in the first half of 2008 were down 8% due to market value losses on invested assets. The trend of revenue per share remains strong but the earnings per share direction is uncertain and should be expected to be volatile.
COMPARABLE STORE SALES: Not Applicable.
VALUE RATIOS: Due to the estimated actuarial nature of earnings the value ratios may not be reliable and earnings could become volatile. The Price to book value ratio seems unattractively high (for a financial company) at 2.3. The dividend yield is good at 2.8% and the dividend has been increasing rapidly. The P/E based on the latest 12 months GAAP earnings is moderately attractive at 14.0. Unfortunately, it is not at all clear if earnings are reliable due to their actuarial nature and certain one-time impacts. Return on Equity was strong at 17.3% in 2007 and had been rising for several years but has slipped slightly in 2008. In the past five years, revenue per share grew at only 6.4% but GAAP earnings per share growth was strong at 14%. The intrinsic value is based on growth (which is hard to forecast) is calculated as $38.22 (7% growth for 5 years and sell at 13 P/E) to $50.68 (12% growth for 5 years and sell at 15 P/E). If the P/E declines modestly to 15 and the earnings continue to grow at least 11.6% annually then this company would provide a total return of 15% which is quite attractive. Overall these value ratios point to a to a Buy rating - but these figures may be unreliable due to the actuarial nature of its accounting.
SUPPORTING RESEARCH AND ANALYSIS
Symbol and Exchange:	MFC, Toronto and New York
Currency:	Canadian $
Category:	Growth
Contact:	investor_relations@manulife.com
Web-site:	www.manulife.com
INCOME AND PRICE / EARNINGS RATIO ANALYSIS
Latest four quarters annual sales $ millions:	$35,151.0
Latest four quarters annual earnings $ millions:	$4,069.0
P/E ratio based on latest four quarters earnings:	14.0
Latest four quarters annual earnings, adjusted, $ millions:	$4,069.0
BASIS OR SOURCE OF ADJUSTED EARNINGS: The earnings appear to be subject to significant smoothing, lumpiness in gains and also one-time events but we have no basis to calculate any meaningful view of adjusted earnings.
Quality of Earnings Measurement and Persistence: Lower certainty of Earnings Measurement and Persistence. Earnings are determined by actuaries who must estimate liabilities due to future death and health benefit claims. Also many gains or losses on investments are smoothed into earnings. Clearly then earnings are estimated rather than observable. However, these estimates are subject to regulations. The pension obligation is not that large compared to the size of the company but the pension accounting has not been very conservative and causes earnings to be over-stated. One danger might be a temptation by management to smooth and manipulate earnings. Substantial income taxes are being deferred which adds to quality. Experience gains accounted for 26% of pre-tax earnings in 2006 and 16% in 2005. We are not at all convinced that this is sustainable.
P/E ratio based on latest four quarters earnings, adjusted	14.0
Latest fiscal year annual earnings:	$4,272.0
P/E ratio based on latest fiscal year earnings:	13.4
Fiscal earnings adjusted:	$4,272.0
P/E ratio for fiscal earnings adjusted:	13.4
Latest four quarters profit as percent of sales	11.6%
Dividend Yield:	2.8%
Price / Sales Ratio	1.62
BALANCE SHEET ITEMS
Price to (diluted) book value ratio:	2.32
Quality of Net Assets and Book Value Measurement: Lower certainty of net assets measurement. Liabilities are determined by actuaries who must estimate liabilities due to future death and health benefit claims. Clearly then liabilities are estimated rather than observable. However, these estimates are subject to regulations. The asset side consists largely of financial items for which measurement certainty should be high. Still, overall the reliability is low.
Number of Diluted common shares in millions:	1,508.0
Controlling Shareholder:
Market Equity Capitalization (Value) $ millions:	$56,550.0
Percentage of assets supported by common equity: (remainder is debt or other liabilities)	14%
Interest-bearing debt as a percentage of common equity	7%
Current assets / current liabilities:	Not Available
Liquidity and capital structure: Liquidity appears to be strong. Insurance companies are always fairly highly levered as assets are much higher than equity. But most of the assets are supported by actuarial liabilities. Interest bearing debt is relatively low.
RETURN ON EQUITY AND ON MARKET VALUE
Latest four quarters adjusted (if applicable) net income return on average equity:	16.6%
Latest fiscal year adjusted (if applicable) net income return on average equity:	17.3%
Adjusted (if applicable) latest four quarters return on market capitalization:	7.2%
GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE
5 years compounded growth in sales/share	6.4%
Volatility of sales growth per share:	Moderate steady growth
5 Years compounded growth in earnings/share	14.1%
5 years compounded growth in adjusted earnings per share	14.1%
Volatility of earnings growth:	Strong steady growth
Projected current year earnings $millions:	not available
Projected price to earnings ratio:	not available
Over the last five years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in earnings per share?	Yes
	Yes
Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained:	10.6%
More conservative estimate of compounded growth in earnings per share over the forecast period:	7.0%
More optimistic estimate of compounded growth in earnings per share over the forecast period:	12.0%
GROWTH OUTLOOK: The medium term outlook for growth appears to be quite strong although slowing somewhat. The company is still gaining strength in Canada and the U.S. Growth in Asia and particularly China should continue to be robust. The outlook for Q3 is quite uncertain given that the currency impact will be positive but the impact of asset valuation changes due to changes in stock values, government interest rates and credits spreads is very uncertain. In addition there will be losses on investments in Lehman and AIG securities. Long-term the company will continue to grow.
Estimated present value per share: We calculate $41.67 if earnings per share grow for 5 years at the more conservative rate of 9.0% and the shares are then sold at a P/E of 15 and $50.35 if earnings per share grow at the more optimistic rate of 12% for 5 years and the shares are then sold at a P/E of 16. Both estimates use a 8% required rate of return. The company's goal is higher than this at 15% EPS growth in the medium term.
ADDITIONAL COMMENTS
INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company's particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition. The industry has barriers to entry in terms of regulations and capital requirements (marginal pass). There are no issues with powerful suppliers (pass). No issues with excessive dependence on powerful customers (pass), No viable substitute products (pass), There is some tendency to compete quite strongly on the basis of price but this is mitigated by sales presentations and the difficulty of comparing offers across products (marginal pass). Overall this appears to be a reasonably attractive industry.
COMPETITIVE ADVANTAGE: Existing economies of scale, strong balance sheet with rare AAA credit rating, strong and innovative suite of financial products, customers, once acquired tend to stay due to the effort it would take to switch and the difficulty of making price comparisons on complex products, access to huge sales force for distribution. Early entrant into China.
RECENT EVENTS: Continued growth in China and continued introduction of new financial products. Manulife will face a write-off that could be approximately $300 million in Q3 due to investments in Lehman and AIG. For context, its normal quarterly earnings are about $1 billion.
ACCOUNTING AND DISCLOSURE ISSUES: Life insurance accounting is complex and based largely on estimates and smoothing as explained under quality of earnings. We found the disclosure to be extensive but in some areas not user friendly. See also comments under quality of earnings and quality of assets. The company reports in Canadian dollars although about 75% of the business is outside Canada, this can distort results. We find it extremely hard to understand why the company was not hurt badly by declining long-term interest rates over the past few years. The Assumed discount rate applied to policy liabilities is hugely important and seemed optimistically high at 8.00% in Canada and 8.50% in the U.S. This was the same as the assumed equity return which also seems high. It seems strange they would use an equity level discount rate when most of their investments are bonds.
COMMON SHARE STRUCTURE USED: Normal, 1 vote per share.
MANAGEMENT QUALITY: Appears to be very high except we are somewhat disappointed with the type of financial disclosure provided. It does not seem user friendly and we believe it does not do a good job of explaining any unusual aspects of the earnings or the actuarial nature. The CEO seems to have an extremely healthy attitude about not over-paying for acquisitions. Presumably the CEO is extremely driven, to have achieved the kind of growth Manulife displays, despite it large size.
EXECUTIVE COMPENSATION: Compensation is certainly generous at $5.4 million for the CEO in 2007 plus $8.4 million in share related compensation and a pension cost of $1.8 million. The CFO was paid about $1.7 million plus about $1.8 million in stock compensation. Given the huge size of this company executive compensation is not an issue even at these high levels.
BOARD OF DIRECTORS: A 14 member Board consisting of distinguished senior and very accomplished business people. Certainly, good management expertise and also strong finance knowledge. However, it is notable that there do appear to be an actuaries on the Board. Actuarial expertise would be beneficial given that Manu life's earnings are driven in large part by complex actuarial models and assumptions.
Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, earnings growth trend and industry attractiveness. We undertake a relatively detailed analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company's growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry.
DISCLAIMER: All stock ratings presented are "generic" in nature and do not take into account the unique circumstances and risk tolerance of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. InvestorsFriend Inc. itself does not have a position in any of the indicated securities while the authors may have a position, as disclosed in each report. The Authors' positions may subsequently change without notice.
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