GNW - Genworth Financial: Heading Towards A Positive Trajectory

2023-03-23 06:55:16 ET

Summary

• Genworth's long-term debt reduction strategy saw it achieve its target of ?$1 billion in FY 2022.
• The liquidity of Enact Holdings did not decline below 13.5% of its outstanding debt in FY 2022 while retaining up to $453 million in cash.
• GNW has been making continuous progress in its long-term care insurance (LTC) action plan which saw its present value reach $23.5 billion in FY 2022.

Genworth Financial Inc. ( GNW ) reported Q4 2022 revenues at $1.895 billion representing an increase of 9.16% (YoY). GNW's Q4 2022 EPS came in at $0.33, +3.13% (YoY) against an adjusted operating income of $167 million, +1.83% (YoY). The robust financials were supported by a positive price return momentum of 26.04% (YoY) and an upside of 23.79% in the last 6 months.

Thesis

The fiscal year 2022 saw Genworth announce the achievement of its debt target of $1.0 billion as the primary step towards the removal of the government-sponsored enterprises ((GSE)) restrictions. This situation will work to return capital to shareholders and boost the company's financial strength allowing greater financial flexibility in 2023. In my estimation, GNW may be considering the separation of Enact Holdings ((ACT)) from long-term care/ life and annuity operations which are not as profitable as the latter.

Key Highlights of Q4 2022

Genworth reported that it paid off its remaining senior notes due in 2024 in line with achieving its long-term debt target of about $1 billion. In its 10-K report, GNW explained that it reduced its total outstanding debt to $887 million and was willing to continue this deleveraging exercise as long as it maintained proper liquidity levels. Since 2013, GNW had reduced its debt levels by up to $3 billion and was now treading on a convenient annual interest expense of $60 million.

Q4 2022 saw GNW attain a net income of $175 million representing $0.35 per diluted share. The full-year 2022 net income stood at $609 million down 3.79% (YoY). The slight decline in net income can be partly attributed to the US GAAP long-duration targeted improvements (LDTI) that presumably forced GNW to alter part of its actuarial, finance, and IT segments in line with new accounting standards and GSE restrictions.

Getting into Q1 2023, GNW believes that it fully satisfies two financial metric conditions related to GSE restrictions on ACT. As per the conditions, Enact Mortgage Insurance Corp- EMICO (GNW's main US mortgage insurance subsidiary) was required to uphold 120% and 115% of Private Mortgage Insurance Eligibility Requirements (PMIERs) least required assets in the FY 2022 and 2021. After 2023, EMICO will need to maintain 125% of its PMIERs minimum required assets.

In the fiscal year ending on December 31, 2020, GNW published a PMIER sufficiency ratio of 137%. This ratio represented $1.23 billion of its available asset requirement. At the time, about 94% of its insured portfolio was covered by its credit risk transfer ((CRT)) program. With the sufficiency ratio at 137%, it meant that the company's metric was above the GSE restriction requirement of 115%.

Fast forward to FY 2022, GNW indicated that Enact Holdings out of its $453 million in cash could retain up to $300 million in cash and that its liquidity must not decline below 13.5% of its outstanding debt. Since GNW's deleveraging is heading below $1 billion, Enact Holdings is supposed to maintain liquidity of at least $203 million.

How it got here

The great recession of 2008 forced GNW like other mortgage insurance businesses to go under, forcing the company to seek help from among other companies China Oceanwide Holdings Group. In 2016, the Beijing-based powerhouse offered to buy out GNW for $2.7 billion to help it offload up to $4.18 billion in debt. However, GNW ended up using its resources to fix its debt crisis and drive it below $1 billion. According to me, it was a relief when bought back $1.143 billion of IOCs due in 2024 and 2034 (in FY 2022) as well as redeemed $152 million of its debt due in 2024.

With its debt level at around $887 million, Genworth is almost entering the next chapter of debt management. By H2 2023, I believe that GNW will be boasting the lowest debt-to-capital ratio in the insurance industry. What follows now, is that Enact will be back in Fannie Mae's and Freddie Mac's good books. Additionally, the removal of the capital requirement will be a positive development for both Enact and Genworth at large.

I expect Genworth to break even in 2023 seeing that insurance regulators in at least 35 states in the US approved its premium rate increases in FY 2022. The policy increases averaged 48% over the annual amount of $1.14 billion received translating to $549 million. Still pending are more increases for the annual reception of $1.23 billion showing a step-up from the industry challenges faced by the company.

Separation of Enact

In September 2021, GNW announced that its ownership of Enact had declined from 100% to 81.16% after selling more than 15 million shares in its IPO. ACT's market cap stands at $3.56 billion while GNW's market cap is almost 30% lower at $2.50 billion.

GNW has been making continuous progress in its long-term care insurance ((LTC)) action plan which saw its present value reach $23.5 billion in FY 2022 since the multi-year rate action plan of 2012.

Enact segment recorded $120 million in its adjusted operating income for Q4 2022 and a total of $578 million for FY 2022. Long-term care insurance stood at $24 million in Q4 2022 and a total of $142 million in FY 2022, a decline of 68.09% (YoY). Life insurance registered an adjusted operating loss of $148 million for FY 2022 while fixed annuities declined 20.9% (YoY) to $72 million.

Enact Holdings pays a dividend rate of $0.56 ((TTM)) on a dividend yield of 2.55%. The company expects regular quarterly dividends from Enact which will in turn be used to cover GNW's debt service costs and other expenses. Since September 2021, GNW has received approximately $370 million in working capital from Enact. In Q4 2022, GNW received $18 million more than the $150 million expected in Q3 2022 indicating strong cash flows from this segment. Enact's insurance in force rose 10% (YoY) to $248 billion boosted by new insurance written in the year.

The global commercial insurance market is forecast to be valued at $777.76 billion in 2023. It is expected to grow at a CAGR of 10.01% by 2028 and reach $1.25 trillion at that time.

Risks to the Downside

Despite the increase in new insurance written demand and high mortgage rates, GNW noted declining affordability that affected overall insurance demand.

Total housing inventory in the US is below long-term levels at 980,000 as of February 2023 from the highs of 1.31 million witnessed in July 2022.

GNW is still riding on a high level of indebtedness despite the marked deleveraging exercise conducted in FY 2022. Further, GNW is determined to continue in its long-term care insurance business despite its struggling nature.

Valuation

GNW is currently trading at a discount when compared to the sum of its principal parts such as Enact (with a $3.56 billion valuation). GNW's P/E GAAP ((TTM)) ratio is 57.41% at 4.26 below the sector average of 10.00 indicating a stronger investment potential.

Bottom Line

I believe that GNW needs to separate its Enact Holding stake from long-term care, life insurance, and fixed annuities to lower its operating losses. The Enact segment was the only profit-making segment in the company during FY 2022. However, the company has assured shareholders of its turnaround strategy which also involves deleveraging that will bring back the company to profitability. With the right adjustment, GNW is positioned for growth and I recommend a hold rating for GNW stock.

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