ACT - Genworth Financial: Trading At A Substantial Discount

2023-03-23 05:39:11 ET

Summary

• The current market capitalization of Enact is around $3.6 billion. Whereas Genworth, which owns around 81.6% stake in Enact, is trading at just $2.5 billion.
• The company has produced over $600 million in net profits, which gives it earnings multiple of about 4 times based on its 2022 earnings.
• Having long-term debt at moderate levels and equity reserves of $10.7 billion provides a significant margin of safety.

Genworth Financial, Inc. ( GNW ) is a provider of mortgage insurance, life insurance, and long-term care insurance. The company's main subsidiary, Enact Holdings (ACT), contributes significantly to the net profits. In the year 2021, the company came up with the minority IPO of Enact holdings; as a result, it has become a publicly traded company, reducing Genworth's ownership in Enact to about 81.6%.

Also, the current market capitalization of Enact is around $3.6 billion. Whereas Genworth, which owns around 81.6% stake in Enact, is trading at just $2.5 billion despite having huge reserves and a strong financial position.

I believe the company's ownership stake in Enact has a value of $2.9 billion based on the current market price of Enact holding shares, which shows that Genworth's stock has been trading at a substantial discount from its actual value.

Historical performance

Since 2013, revenue has dropped from over $8.6 billion to about $7.5 billion by 2022. Over the same period, net profit has fluctuated significantly, ranging from $1.2 billion of loss in 2014 to about $600 million profit in FY 2022.

The opening margins seem to have been substantially volatile and may remain volatile in the future. The company has reported strong profits during the last two years due to its strong underwriting performance.

Over the last few years, the management has been focused on debt reduction; as a result, long-term debt has gone down from over $3.4 billion to about $1.6 billion. Also, the company has over $1.7 billion in cash reserves and over $10 billion in shareholders' equity, which significantly strengthens its financial position.

Although the operating performance seems to have increased in the last two years, the stock price has not appreciated much and fluctuated at the same levels.

Since the drop in 2020, the stock price has increased over 140%, but as compared to the 2019 levels, the returns are not so attractive. The stock is currently trading for $5 per share, providing the company with a market capitalization of over $2.5 billion.

Strength in the business model

Given we have reduced Genworth Holdings' debt to below $1.0 billion and believe we have met the GSE conditions, we intend to accelerate the pace of share repurchases in 2023. However, the timing and number of future shares repurchased under the program will depend on a variety of factors, including stock price, trading volume, and general business and market conditions.

Debt reduction has been a priority for the company; as a result, outstanding debt has decreased overall. In the upcoming years, these initiatives will further strengthen the business model. Also, the company's board has authorized a share repurchase program, which is expected to create substantial value for the shareholders.

On February 16, 2023, S&P upgraded the credit rating of Genworth Financial and Genworth Holdings to "BB-" from "B+" with an outlook of stable and upgraded the financial strength rating of EMICO to "BBB+" from "BBB." Previously, on March 11, 2022, S&P upgraded the credit rating of Genworth Financial and Genworth Holdings to "B+" from "B" and affirmed its "BBB" financial strength rating of EMICO.

Due to the improved liquidity and financial stability, rating agencies have improved credit ratings for the company, which is a significantly important factor for an insurance company. Strong financial strength ratings will help the company attract more reasonably priced premiums.

Risk factors

While the business is substantially undervalued compared to its equity reserves, various risk factors can affect its performance, which might result in stock price correction.

Although the management's main focus is developing the long-term care insurance business, the segment still struggles with substantial losses. If the losses persist for a longer duration, it might affect the operating results.

Furthermore, the company has incurred about $4.8 billion in unrealized losses on its Fixed maturity securities. If the company owns these securities, then there won't be any issue regarding unrealized losses, but in my view, if the losses widen, it can affect financial strength ratings. As a result, the company might face challenges in obtaining reinsurance and writing premiums.

Recent development

In 2022, the revenue dropped from $7.8 billion in FY 2021 to about $7.5 billion, primarily attributed to net investment loss compared to a significant investment gain during the last 2-year period. Also, over the last three years, income from continuing operations has been strong, but due to losses from discontinuous operations, the net profits have reduced significantly during FY 2020.

Also, consider that the recently improved underwriting performance is primarily attributed to the reduced rate of delinquency. If the delinquency rate rises again, the net profits might drop. But the overall underwriting performance seems attractive.

Currently, the company is trading for about $2.5 billion. In contrast, it has produced over $600 million in net profits, which gives it earnings multiple of about 4 times based on its 2022 earnings. Having long-term debt at moderate levels and equity reserves of $10.7 billion provides a significant margin of safety. Therefore, I assign a BUY rating to the stock. The stock has become significantly undervalued and can provide huge returns to long-term investors.

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