Improving equity markets and easing credit risk is expected to help Canada's struggling life insurance sector return to more normal earnings over the next few quarters,
Add in attractive relative valuations to the banks, and the upside potential for lifeco stocks is compelling, says Michael Goldberg, analyst, Desjardins Securities.
"Though we believe that the return to historical valuations is likely to take time, the trend should begin as lifecos prove that their recurring earnings are moving back to at least steady normalized levels with much less volatility and noise," he said in a note to clients.
Mr. Goldberg said Canadian lifecos have historically traded at similar multiples to country's banks on both a price/earnings and price-to-book value basis. However, over the past year, life insurance companies have largely underperformed and in the fourth quarter of 2009, fell 8.3% as a group on the Toronto Stock Exchange, compared to a drop of just 0.6% for the banks.
"…Unlike the banks, lifecos as public companies have not gone through a severe economic downturn before. Therefore, investors are less confident in the ability of the lifecos vs the banks to return to normalized earnings, which has in effect held back their valuations," he said.
Noting a preference for lifecos over banks, Mr. Goldberg said the earnings success of country's top four life insurance companies largely depends on their individual exposures to equity and credit risk.
"We believe Manulife Financial Corp. will benefit the most from the direction of these drivers, given it is the most sensitive to equity risk and relatively low credit concerns," he said. maintaining his top pick rating and $25 price target.
"Great-West Lifeco., which has reported relatively stable earnings year to date, should benefit the least as it has the lowest equity market sensitivity but relatively high credit risk."
Mr. Goldberg has a Hold rating on Great-West with a $28.50 price target. Meanwhile, Sun Life Financial is also rated Hold with a $34 target and Industrial Alliance is a Buy at a target of $37.