I was preparing a column on how Sun Life Financial, having emerged from the financial crisis with a strong capital position, yet priced at just about its book value, seemed a good buy. But I didn’t get it written before Oct. 17.
Good for me (and you), since that was the day Sun Life shocked and disappointed investors with the news it would report a third-quarter loss of $621-million, compared with the roughly $260-million profit analysts had been expecting. The stock dropped 9 per cent that day and still struggles to recover. (The company reports quarterly results Wednesday.)
The scope of that loss, and the fact it was a surprise, is a strong reminder of the risk involved in buying the stock of even the most stable life insurers. After all, if neither the company nor the professional analysts who follow it can accurately forecast results, how can the average investor figure it out?
The idea that Sun Life would have some degree of difficulty in the third quarter should not have been shocking; a significant portion of the company’s business comes from life insurance and annuity products whose performance depends on both the stock market and interest rates. And as Sun Life noted in its announcement, North American equity markets dropped between 12 per cent and 14 per cent in the third quarter, while fixed-income yields fell, with U.S. government securities reaching historic lows.
Of course, these market statistics were shaping up all through the quarter and were final by Sept. 30, nearly two weeks before the company’s surprise announcement.
As analyst Ohad Lederer of Veritas Investment Research points out, Sun Life had previously published a “sensitivity” analysis that spelled out what market changes meant for profits. Sun Life had said a 10-per-cent decline in the equity market should have an impact of $125-million to $175-million, while a drop of one percentage point in rates should cost it $200-million to $300-million.
Mr. Lederer used that sensitivity analysis to estimate a $600-million hit, offset by $425-million in underlying earnings, adding up to a loss of less than $200-million. (Sun Life’s disclosure also included an extra $200-million of losses from changes in actuarial assumptions.) “We are surprised – as is everyone, it seems – at the severity of the loss,” he said.
Tom MacKinnon of BMO Nesbitt Burns Inc., said, “For a company that has done better than the sensitivity guidance in the last two quarters, this comes as a negative surprise.” (He does not expect something similar from Manulife Financial, which has been providing investors with negative surprises for the last two years, because Manulife now has “more granular disclosure and guidance on macro impacts.” Manulife reports third-quarter results Thursday.)
Sun Life still shows up when value-oriented investors screen stocks for hot prospects; its dividend yield topped 6 per cent while its price-to-book ratio, a key indicator for financial stock, was below 1.0, making it indisputably cheap. With the recent declines, both measures have made it seem an even better buy.
Yet Mr. Lederer of Veritas, who now has a “sell” rating on the company, notes the loss Sun Life will take in the third quarter will drop its primary capital ratio from 231 per cent to 210 per cent, leaving it vulnerable to continued negative moves in equities and fixed income. “Two-thirds of its capital buffer over 200 per cent is gone in just one quarter; today, Sun Life is a company with a small(er) capital buffer, likely heightened sensitivities to markets, and potentially lower underlying profitability.”
And analyst Peter Routledge of National Bank Financial Inc., who initiated coverage with a “sector perform” rating, believes Sun Life’s U.S. operations, where most of its lines of business struggle to crack the top 10, will fail to return profits greater than Sun Life’s cost of capital for the foreseeable future. As for the earnings warning? “It is too early to conclude definitively on this issue – we will refine our view after evaluating Sun Life’s [third quarter]earnings release.”
Investors are often told to buy stock in companies that make products that are easy to understand; I typically don’t endorse the advice because to me, it suggests hard-to-understand businesses are undervalued. But in this case, to paraphrase former U.S. defence secretary Donald Rumsfeld, Sun Life’s “known unknowns” are troubling enough to make the company’s shares more risky than cheap.