FNF - F&G Annuities & Life Drops Despite Solid Q1 Earnings

2023-05-05 11:22:52 ET

Summary

• F&G Annuities & Life, Inc. headlines reported a large EPS "miss." But after adjusting for tax expenses and some mark-to-market investments, F&G earned $0.95 in EPS.
• That was well ahead of $0.67 estimates. F&G Annuities & Life, Inc. stock fell over 15%.
• Limited liquidity and wholesale selling of smaller-cap financials contributed to the stock's decline.
• We like F&G Annuities & Life, Inc. stock here and review earnings but recognize that credit risks linger.

Earnings

Note that Fidelity National Financial, Inc. ( FNF ) owns 85% of F&G Annuities & Life, Inc. (FG).

F&G reported Q1 earnings on Thursday and the stock fell 17%. We expect most of the hit is based on a: 1) misunderstanding of the company’s adjusted earnings (as we describe below); 2) perhaps office real estate and credit fears, but they were not asked about this on the call; and 3) insurance industry pain in small cap financials on Thursday (as MET was down 7%, LNC down 10%, GENW down 14%, EQT down 8%).

With F&G Annuities, the headline EPS miss ($0.39 vs $0.68 estimates) did not really capture the reality of earnings. Here is a breakdown of F&G EPS vs. expectations and a year ago.

While adjusted EPS was reported at $0.39, adjusted for new mark-to-market rules (which just add volatility to earnings) and some tax items, economic adjusted EPS was $0.95 , well ahead of expectations.

As a gut check, management mentioned on their earnings call that adjusted EPS was slightly better than the 1.0% of AUM ballpark (1.07% was specifically stated).

1.07% of AUM translates to quarterly EPS of $0.94.

That puts EPS down ~13% sequentially, but up 21% year-over-year. With all financials of late, the market is shooting first and asking questions later.

On the sales side, gross sales were up 27% year over year and 22% sequentially.

Net sales, which is net of ceded insurance policies, were $2.20 billion as the company reinsured 33% of new gross sales in the quarter. That was down from only 8% of gross sales ceded a year ago. That pushed net sales down by $150 million (from $2.35 billion a year ago). That is a decline of 6.3%.

Still, ceded contracts allow the company to convert spread sales to lower-risk fee-based sales. They also keep the highest spread/highest ROE business on the books.

Assets under management ((AUM)) grew to a record $45 billion, up 18% year-over-year.

Here is a good summary slide.

We suspect the selloff was perhaps partly related to concerns surrounding the company’s investment portfolio/credit concerns.

On the plus side, life/annuity businesses, unlike banks, do not mismatch duration (or at least F&G does not). They have long-dated liabilities and long-dated assets. 88% of FG’s policies are non-surrenderable too, meaning no runs on deposits/assets.

In April, the company mentioned “slightly elevated” surrenders but still experienced net inflows. Even if surrenders spiked, fees would push earnings HIGHER and free up capital for even more growth.

On the portfolio side, 94% of their portfolio is in fixed-income investments. 95% of F&G’s investments are investment grade rated and 18% is floating rate. The portfolio yields 4.33% up from 3.73% a year ago.

Office is 3% of the total portfolio, or $1 billion , and arguably could be a $300 million hit (at 70c on the dollar, where BBB CMBX is trading). That would be a hit of $2.40 to book value (which was $19.72 per share on a mark-to-market basis, or $39.94 ex-AOCI). We give this credit perhaps for the stock's $3 decline. On the plus side, the company marks their book to market, so potentially this is already marked down.

Their Alts portfolio is the other 6% of the portfolio and is a mix of private equity/real estate. It has minimal office exposure.

Collateralized loan obligation, or CLOs, are 10% of the portfolio (in the fixed income category) and 95% investment grade.

Still, the company is on positive watch from AM Best and Moody’s and has a healthy $2.4 billion of cash and investment securities to fund any liquidity needs. Debt to cap is also low at 24%. The bonds traded up slightly on Thursday, while the stock fell.

Finally, the company restated prior year financials for new LDTI accounting rules (which we frankly will not attempt to fully understand). Net 2021 and 2022 prior year earnings were revised higher by 5%, but now show lots more volatility given the MTM change.

2021 EPS was bumped up $1 to $6.25, but 2022 lowered by $0.15 from $3.00 to $2.85.

With AUM growing, we hazard a guess that at 1.05% net income to AUM and EPS will be $3.60 in 2023.

As for F&G Annuities & Life, Inc. stock’s volatility today, small-cap financials are in panic sell mode. Trying to time a bottom or an end to this is potentially fruitless. We are not expecting any miracles near term but find the long-term story very compelling. Importantly, there seems little fear in the bond market today regarding most of the securities that F&G holds. Investment grade and high yield spreads have only widened moderately and are below the highs of 2022.

We speculated last year that $15 could be downside potential in F&G stock. We seem to be there. At even $3 in EPS, F&G is trading at 5x forward and a 5.3% yield, for a premier insurer with no legacy baggage or run-off assets. Does that go to 7-8%? We simply don’t know but recognize that limited liquidity in FG (as only 15% of the float is publicly traded) could mean exaggerated moves in the equity.

Personally, I view F&G Annuities & Life, Inc. as a buy here, but will keep dry powder for further panic moves down. At an 8% yield, FNF would trade to $10, where we would get pretty aggressive size-wise.

The biggest risk to F&G is simply another material move higher in yields. The office portfolio does not seem large enough to force an equity raise or dividend cut in and of itself. But a large credit hit could be a factor.

Note that book value fell by half in 2022 from $5.0 billion to $2.5 billion (but grew 4% from the end of 2022 to the end of March as yields have stabilized). Ex-AOCI book has remained steady, from $40.01 as of the end of 2021 to $39.94 per share as of the end of March.

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