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Discerning investors enticed by Genworth MI

It's a value investor's dream: A solid, nearly debt-free company trading at around book value, with a single-digit earnings multiple and a juicy dividend yield approaching 4 per cent.

That, in a thumbnail, is the investment case for Genworth the country's only publicly traded competitor to federally owned Canada Mortgage and Housing Corp. in the market for insuring lenders against homeowner mortgage defaults.

Investors might be forgiven for not having heard much about Genworth MI, even though it is one of the major insurance operators in the country.

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The company only went public a year ago, placing it as one of the top 10 newcomers to the Canadian equity market last year, as ranked by Report on Business Magazine's Top 1000 publicly traded Canadian companies.

The shares came on the market after U.S. parent, insurance provider Genworth Financial Inc., was forced to raise money through an initial public offering to bolster its capital position during the U.S. housing meltdown.

Given investor anxiety over mortgages, Genworth MI shares have been hit in recent months by fears that Canada's high flying residential real estate market could go the way of the U.S. housing bubble. But value investors say the worries are overblown and are creating a compelling opportunity in the stock at current prices.

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One of Canada's best known value players, Irwin Michael, portfolio manager of ABC Funds, has been singing the praises of Genworth MI. The shares were also highlighted in Barron's magazine's Roundtable panel of stock picks earlier this year, cited as a top pick by Meryl Witmer, a general partner at Eagle Capital Partners in New York.

Mr. Michael couldn't be reached for comment, but a recent letter to fund investors lauded Genworth MI's fundamentals, and "while waiting" for these to be recognized in the market "investors should be pleased to hold a stock that yields approximately 4 per cent at current price levels."

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His fund has a one year target on the stock of $34, or 47 per cent more than its recent $23.20 trading level.

The shares went public at $19 and the U.S. parent retains a 57.5 per cent ownership stake.

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Bond rating firm DBRS Ltd. ranks Genworth MI at double-A (low). In a recent report, it dismissed worries that the domestic mortgage market had much in common with that of the U.S., saying Canada's "is fundamentally conservative," with such benefits as more borrower recourse against defaulters and fewer tax incentives for people to take on excessive debt.

Five of the seven analysts tracked by Bloomberg rate it as a "buy." Two call it a "hold."

The most optimistic call on the stock is by Scotia Capital Inc. analyst Phil Hardie, who rates the company an "outperform" and has a one-year target of $35.

"The Genworth story is not really well understood," Mr. Hardie contends. "We think Genworth is a high quality blue chip company. It's well positioned [to benefit]from Canada's recovery in labour markets."

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The bearish case on the company holds that Canada's hot real estate market is due for a tumble, and that mortgage insurers will be on the hook for big losses.

But Mr. Hardie argues buoyant job growth should allay any fears that homeowners will walk away in large numbers from their loans. Even if a house price falls below the mortgage level, owners are unlikely to send in the keys because Canada allows wages to be garnisheed, another protection for Genworth MI.

Any value stock story needs a catalyst, and the company has several.

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Genworth MI has surplus cash and is expected to either buy back shares or issue a hefty special dividend to return money to stockholders. Investors are also hopeful that the regular dividend, now at 22 cents per quarter, will be raised at the end of the year. The company, once it has traded for more than a year, may also be placed in the S&P/TSX composite index.

Genworth MI has a book value of $23 a share, but Mr. Hardie says it also has about $5 a share of after-tax profits embedded in the unearned premiums from the insurance premiums it has collected, suggesting an underlying value of $28 a share.

"As investors become more comfortable with the name, they'll understand the dynamics and really understand the robustness of the business mode," Mr. Hardie said.

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