Manulife continues to operate above any regulatory minimum for their capital ratios and have not yet taken significant losses attributed to these products.
Presentation
Fact Sheet

So now I have to try and answer some difficult questions:

• Do I trust management?
• Do I approve of the plan for CEO succession?
• Is the business model and business operations sustainable?
• Will the company continue to be profitable?
• Is there an element of Enduring Value?
• Have any competitive disadvantages emerged?
• Do strong fundamentals of the business, markets and customers remain?
• What am I willing to pay for the risks that have been highlighted?

At this point in my analysis I want to go back to the numbers to see how the company has performed by putting their business model into perspective. I know from following the company that earnings have not benefited or been inflated from the business being over leveraged as we saw in recent years with many large financial instituions. The company does not have material exposure to derivatives or subprime mortgages and the company has never been investigated or performed questionable accounting.

Going back to 1995 I have the following historical data on the company:

ROE: 14.8%
Div Yield: 1.75%
Payout: 25.9%
P/E: 15.4x
P/B: 2.32
Div Growth: 22.3%
BV Growth: 12.2%

Current Data:
Dividend: $1.04
BVPS: $15.80
EPS (ttm): $2.70
Yield: 4.20%
Payout: 38.5%
P/B: 1.58x

If I apply my dividend discount model to determine a FMV for Manulife as previously shown I have a few issues first to resolve.

(For investors looking to gain insight into my rationale of the next section please review parts III and IV of my fundamental analysis series).

As a value investor I need to recognize a few potential outcomes of any investment in this environment. I know that earnings, over the interim, are likely to either compress due to market weakness or stagnate under continued growth pressures. There’s also potential that an investment will experience dilution from issuance of additional common shares in the event the company needs to raise capital (assume 10% dilution). Despite my confidence in strong operating fundamentals of the company I need to provide a realistic valuation to best protect myself from risk.

I have a few options:

• I can stay consistent with my traditional valuation method
• Increase my discount rate beyond 25% to 50% to account for the greater equity risk
• Discount my expectations of full EPS for the full year 2009
• Take into consideration a worst case scenario of a 50% drop in EPS & 40% cut to the dividend

Growth Rate = (Historical ROE / Current P/B) + Historical BV Growth)



As you can see this gives me a wide range of potential valuations depending on how risky I view the investment to be. When I summarize my situational analysis, including all potential outcomes for risk, I’m confident in selecting #3 as the most appropriate valuation at this time disclosing to readers that #1 is my original FMV through which I bought the shares in May of 2007.

My reasoning for choosing #3:

The company has a targeted dividend payout of 25-35% and the payout currently sits at 38.5% which is only slightly above the historical high side for the company. The dividend in my view is safe as the company’s revenues and earnings are diversified in a number of markets and financial products. The company has adequate financial resources to sustain the dividend and earnings, as of right now, have not shown any substantial weakness that would indicate otherwise. Capital ratios for the company remain above regulatory thresholds and investments are diversified by risk in a number of asset classes and groups.

I do expect earnings to drop slightly as write-downs and loss provisions are taken to better position the company for an eventual acquisition. What I don’t anticipate is a drop of greater than 20% to full EPS for 2009 from their current level.

At current prices Manulife is likely undervalued by approximately 15% or more. At its recent 52-week low of under $22 my analysis indicates that the market perceived a drop of 50% in EPS for 2009 and a dividend cut of 40% or was looking for an adequate margin of safety nearing 50%. While I cannot rule out the possibility of a serious earnings decline or dividend cut my experience, analysis and confidence in management indicate to me that the outcome for a dividend cut and sustained drop in earnings is remote.

If the company were to issue common shares to the effect of a 10% dilution I would take the opportunity to add to my position as I view that move as prudent given the current market environment and potential for accretive acquisitions. The company is a long-term investment for my portfolio and has been wonderfully managed before this crisis to position itself in a conservative financial position and I don’t see signs of that changing now. Management was not motivated to take extreme risks in their financial products and the investment portfolio is well diversified in terms of risk. While I can’t promise that losses from certain investments won’t have an impact on earnings I do have confidence in the ability of current management to position Manulife for growth moving forward.