* Top insurers set to report a strong fourth quarter
* Stocks rose 20-40 pct in 2012
* Analysts say bond yields don't justify stock levels
By Cameron French
TORONTO, Feb 3 After ringing up share-price
gains last year that led the market, Canada's life insurers look
ripe for a setback even if they post blockbuster quarterly
results over the next couple of weeks.
Insurers such as Sun Life Financial Inc and
Manulife Financial Corp have reduced their exposure to
equity markets over the past two years, but their shares are
heavily influenced by bond yield movements.
While yields have been on the rise since hitting historical
lows last July, Canadian insurance stocks have positively
sky-rocketed. That suggests that investors are betting on a
further substantial rise in yields, a gamble that not everyone
is willing to make.
"The Canadian lifeco valuations suggest a steepening of the
yield curve, a pretty considerable one," said Peter Routledge,
an analyst at National Bank Financial, referring to a graph of
rising long-term bond yields. "That's a big bet and it's not one
that we'd make."
Higher yields make the insurers' investment products more
appealing and also increase the expected returns from the bonds
they hold to offset their long-dated insurance liabilities.
But shares of the insurers - after rising between about 20
and 40 percent last year and even further in January - already
reflect a rich premium.
STOCKS CHARGING AHEAD
"A ton of positive news is being priced in at this stage of
the game," said John Aiken, an analyst at Barclays Capital.
Shares of Sun Life, Canada's No. 3 insurer, rose 39.5
percent last year, while larger rival Manulife gained 24.5
percent. Great-West Lifeco and Industrial Alliance
Insurance and Financial Services Inc, the sector's No.
2 and 4 players, both climbed 19.4 percent.
That compares with a 4 percent rise for Canada's benchmark
stock index, the S&P/TSX composite.
U.S. 10-year bond yields, which analysts often
use as a benchmark, rose to 1.76 percent at the end of 2012 from
a low of 1.39 percent in July. They have since climbed above 2
"The rug may not get pulled out from underneath (the
insurers), but the march in the evolution of the valuation
multiples has got to come to an end," Aiken said.
The four insurers now trade at about 12 times one-year
forward earnings, according to Thomson Reuters data, and have
higher valuations than all of the country's major banks.
STRONG QUARTER EXPECTED
Even though bond movements may not justify the valuations,
analysts are expecting fourth-quarter results that should
compare well to the fourth quarter of 2011, when profits were
stung by volatile markets and one-time charges.
Manulife will be the first insurer to report, on Thursday,
and is expected to post a profit of 32 Canadian cents a share,
versus a loss of 5 Canadian cents a year earlier.
Sun Life is expected to earn a net 38 Canadian cents a
share, versus a loss of 90 Canadian cents, while Great-West's
EPS is expected at 46 Canadian cents, down from 65 Canadian
Industrial Alliance, the final insurer to report, on Feb.
15, is seen earning 71 Canadian cents a share, compared with a
steep loss of 90 Canadian cents a year earlier.
With little drama expected, and with both equity and bond
yields on the rise, investors may already be looking past the
"People are expecting a relatively benign environment from
the last quarter, but they're more concerned with what's coming
up front," said Michael Sprung, president of Sprung Investment
This could include hints from management about how the
recent rise in bond yields will affect future results.
While the insurers may be pricey based on current market
factors, they seem better positioned than most to benefit from
an economic recovery.
Once among the largest stocks on the Toronto Stock Exchange,
the insurers were hit harder than most by the 2008 market crash,
which turned many of their insurance and investment products
into money-losers and forced them to take billions in charges.
They responded by hedging much of their market exposure, and
shedding money-losing assets. Sun Life, for instance, announced
in December the sale of its U.S. annuity business.
Manulife and Sun Life have also focused on expanding their
operations in Asia, where they see favorable demographics and a
low penetration of insurance products.
But even with the recent stock gains, Manulife is trading at
barely a third of its record high, set in 2007, while Sun Life
is trading at just over half of its record high, giving them
plenty of room to rise if and when bond yields emerge further
from the remarkably low levels of the past two years.
Despite their recent rise, bond yields are still low on an
historical basis. As recently as 2011, the U.S. 10-year Treasury
yielded 3.5 percent, and the yield was above 5 percent before
the 2008 financial crisis.
For the time being, analysts say they are approaching the
sector with caution, at least until market fundamentals offer
more support for their current prices.
"The relative risk/return now isn't very good and I wouldn't
be surprised if that's what came out of the quarter and you saw
a little bit of consolidation," said National Bank's Routledge.