It isn’t every day that the market offers investors an opportunity to buy $1 for only about 25 cents, but just such an intriguing deal is available through the shares of Genworth Financial Inc.
The beaten-down U.S. mortgage insurer and life insurance company is trading for only 25 per cent of its book value, or the amount left over if its assets and liabilities were to be liquidated. While it’s obvious that a company trading at those levels is viewed as seriously damaged goods, the question for investors is whether the yawning chasm between its share price and break up value is just too huge.
On that score, it’s interesting to note that Seth Klarman, the fabled U.S. value investing guru, is a believer. His Baupost Group is one of the company’s largest shareholders, with 15 million shares worth $120-million (U.S.), for a 3 per cent stake.
It isn’t every day that ordinary investors can take a position alongside a money manager of Mr. Klarman’s calibre. If he sees a gem in a publicly traded stock that the street has priced as a dog, it’s worth a closer look.
Genworth isn’t an obscure, fly-by-night company. It had $114-billion in assets at last count. It has a respectable corporate pedigree, having been spun out of conglomerate General Electric Co. nearly a decade ago. Besides mortgage insurance, it offers traditional life insurance and is one of the largest providers of long-term care insurance in the United States. Its credit rating is triple B minus, still investment grade, although just a notch above junk status.
Canadians may be familiar with the name – its Canadian-owned affiliate, Genworth MI Canada Inc., trades in Toronto and is the profitable No. 2 player in the domestic mortgage insurance market after federally owned Canada Mortgage and Housing Corp.
The company also has a medium-sized money management business, and offers mortgage insurance in Australia.
The thesis of the bulls is that Genworth has a likely catalyst that could move the shares upward: the U.S. housing market recovery. Most of the liar loans and other dubious mortgages Genworth insured before the crash are being run down. The home loans insured since 2008 are highly profitable, and exhibit excellent underwriting standards. The company figures its U.S. mortgage business should return to profitability this year, a welcome development after years of losses.
The shares have rallied a bit on hopes for the housing recovery, but not nearly exhausting the upside potential. “We’ve seen the shares appreciate somewhat but they are still, in our view, no way reflective of the company’s inherent value,” contends Mark Palmer, analyst in New York for BTIC, an investment dealer that caters to institutional clients. He rates the stock a “buy” and has an $11 target.
A short foray into some of the moving parts of the Genworth balance sheet illustrates why the market may be mispricing the company. The stock had a book value at Dec. 31 of $33.62 a share, compared to its recent market stock price of about $8.50.
Meanwhile, its market capitalization stands at $4.2-billion – but its share of the Canadian subsidiary is worth $1.4-billion and the Australian unit about $2.3-billion. Strip out these assets, and investors are getting the rest of the company almost for free, with the added kicker that the U.S. mortgage business is in the early stages of a turnaround.
Mr. Palmer did some number crunching along these lines in 2011 when he initiated coverage on the company and calculated the life insurance and wealth management operation was trading at only 1.8 times earnings, a rock bottom valuation. He said not much has changed since then and the rest of the company is available at a “dirt cheap” multiple.
The big knock against Genworth and the reason it’s trading so cheaply is that it hasn’t been very profitable, earning a return on equity of only 3 per cent last year, although that shouldn’t be too much of a concern for investors buying in at one quarter of book. They’re in effect earning 12 per cent.
To be sure, not everyone thinks the shares are cheap. J.P. Morgan analysts have an $8 price target and a “neutral” call. They’re cautious because of the low returns in the life division and concerns that the U.S. mortgage insurance business, while in a turnaround, will have modest returns for the next few years. As a life insurance company, Genworth is also harmed by low interest rates, which cut returns on its bond investments.
There is another, more conservative way to play the stock, and that is through the Canadian subsidiary, Genworth MI. It’s trading at just under book value and sports an attractive 5.1 per cent yield. The struggles of the U.S. parent are the likely reasons the stock is inexpensive.
Canadian value investor and money manager Irwin Michael has picked up the Canadian stock. He says the Canadian operation is Genworth’s best asset, but says both companies are “fundamentally cheap” and “under appreciated” by investors.