2023-07-23 23:33:45 ET
Summary
- Sun Life Financial gets a hold/neutral rating today.
- Positives: positive YoY net income growth, capital & liquidity strength, and dividend yield above 4% is higher than its sector average.
- Headwinds: P/E and P/B valuations are higher than the sector average, and the current share price is 10% above 200-day SMA which we think is overheated.
- I expect SLF to remain on the same trajectory of conservatively managing its portfolio and continuing to reduce exposure to office properties.
Research Brief
In spirit of the extreme summer heat wave stretching across many parts of America & Europe in recent weeks, today's research analysis is a real scorcher as we cover none other than Sun Life Financial ( SLF ).
This company, whose business segments include insurance, investments, financial advisory, and asset management, is expected to report its Q2 earnings results on August 8th.
Some notable mentions from its company website include: serves clients across Canada, US, UK, Asia; based in Toronto but also trades on NYSE, has a network of advisors & agents through which insurance & other products are distributed.
Today's research analysis will answer the question: is this stock currently a value opportunity for investors looking for an established & existing income stream to invest into?
Ratings Methodology
Our goal is to find undervalued stocks of companies with solid financial fundamentals, that pay competitive dividend yields. Our key industry focus is tech, financials, insurance, innovation.
To simplify my rating of an equity, I have broken it down into whether I would recommend or not recommend based on these individual factors:
- Valuation vs Sector Average
- Dividend Yield vs Sector Average
- Positive YoY Net Income Growth
- Capital & Liquidity Strength
- Stock Price vs 200 Day SMA
If I recommend on all 5 categories, it is a "strong buy", 4 categories is a "buy", 3 is a hold, and less than that is a sell rating. Then I compare my rating to the consensus ratings from Seeking Alpha & Wall Street.
Valuation vs. Sector Average: Not Recommended
For starters, there are two metrics we care about when it comes to valuation: the GAAP-based forward price to earnings ratio (P/E ratio) and the forward price to book (P/B) ratio, as well as a comparison to the industry average for this company.
Below, taken from Seeking Alpha data , we can see that the P/E as of July 22 is 11.18, earning it a "C" grade from Seeking Alpha and being over 11% vs the average valuation for this sector:
Sun Life - P/E ratio (Seeking Alpha)
Our goal is to find stocks whose P/E ratio is at or below the sector average, or at most 10% above it. In this case, the P/E is much higher vs the sector average than we would like.
Next, let's look at the P/B ratio. As you can see, it is currently 1.75, which Seeking Alpha gave a "D+" grade to, and is 68% above the sector average:
Sun Life - P/B Ratio (Seeking Alpha)
This too is much higher than we would like, as our own target puts the P/B ratio somewhere within 10% of the sector average.
Because of these two metrics, we do not recommend this stock at this time on the basis of valuation, and consider it overvalued, even though we are recommending it in some of the other categories today.
Dividend Yield vs. Sector Average: Recommend
This stock currently pays $0.55 per share, with a dividend yield of 4.11% as of July 22, according to official data . Below is a summary:
Later on in the article, our portfolio simulator shows how a dividend-income investor can benefit from this stock.
Notable to mention is the 5 year dividend growth as well, as seen below, which has seen annual dividends grow steadily from 2018 to 2022:
What will set this stock apart, in my opinion, is its dividend yield compared to its sector average. In this case, its yield is over 15% above its sector average, a positive sign:
Sun Life - dividend yield vs sector (Seeking Alpha)
Based on the above evidence, we recommend this stock in the category of dividends, not only for having a yield above 4% but also being higher than its industry average.
Positive YoY Net Income Growth: Recommend
While we wait a few weeks for Q2 results, for today's analysis we will use the Q1 figures, which were impressive. For example, profitability increased on a YoY basis include net income and earnings per share:
Sun Life - Q1 YoY profitability (Sun Life - Q1 earnings release)
Also notable to mention is income diversification since this firm has multiple business segments all of which are generating money. It also has market penetration across multiple geographic regions.
Consider the following geomap which shows just how geographically diversified this firm is, with penetration across multiple continents. We see this as a positive for this brand, because it makes it truly a "global" business that can generate income across multiple regions:
Also, when looking at their income statement and what are the top-line drivers of gross revenue for this firm, in the 1 year period from 2022Q1 to 2023Q1, we see not only YoY growth in 3 out of 4 revenue sources but also revenue diversification across premiums, interest/dividend income, and gains from sales of investments, in addition to "other" revenue:
From the data provided, we recommend this stock on the basis of positive YoY net income growth, and like their income diversification as well as geographic market penetration. It is a well-established net income stream that is already proven each quarter for quite some time now.
Capital & Liquidity Strength of Company: Recommend
When it comes to gauging the capital strength of this firm, since it is a Canada-based firm it is subject to rules by Canadian regulator OSFI (Superintendent of Financial Institutions).
According to OSFI, "Companies are required, at minimum, to maintain a Core Ratio of 55% and a Total Ratio of 90%. OSFI has established supervisory target levels of 70% for Core and 100% for Total capital."
Sun Life exceeds these, as seen in their Q1 figures which show a LICAT of well over 100%:
Sun Life - Q1 - LICAT ratio (Sun Life - Q1 presentation)
Also notable to mention is their financial leverage ratio which is around 23%, and has decreased. As we don't come across this metric in all of the companies we write about, in the context of this firm it is best defined by industry standards as follows: "a financial leverage ratio refers to the amount of obligation or debt a company has been or will be using to finance its business operations."
So, the figures show a LICAT well in excess of regulation and an ((FLR)) showing improvement.
Lastly, I want to know how liquid this company is. From the Q1 figures, it is a cash-rich firm with $1.1B in cash and other liquid assets, as shown in the table below, and saw an increase in this over the prior quarter:
From the evidence shown, I am confident this firm is sustainable and I expect similar results in Q2 coming soon in the next earnings call.
So, I recommend this stock on the basis of its company's capital & liquidity strength.
Stock Price vs. 200-Day SMA: Not Recommended
Next, let's discuss the share price for this stock as of market close on Friday July 21st, when it closed at $52.58, as shown below:
In the chart above, we are tracking the share price vs the 200 day simple moving average, over a period of the prior 1 year.
Our portfolio strategy is to track the 200 day SMA as a long-term trend indicator, and find a buy/sell range within 5% of the SMA.
In this case, the 200-day average being $47.49, our target trading range is $45.11 - $49.86. The fact that the current share price is at $52.58 puts it beyond our trading range, and we do not recommend it as a buy since we consider it overpriced now, almost 11% above its 200 day SMA.
Below is a simulation of our trading strategy that addresses questions we get such as target buy price and desired holding timeframe, and exit price target:
In the above example, we are buying 100sh at $45.11 (5% below the current 200 day SMA), holding for 1 year to earn the full dividend yield, and selling at $49.86 (5% above the current 200 day SMA). Our total return on capital invested is 15.41%. This strategy depends on entering & exiting the stock within the price spread shown. We prefer tracking the 200 day SMA as a long-term investor, rather than trying to "time" shorter-term averages like the 50 day.
*Cautionary Note: This may or may not fit your own portfolio strategy and is just an example. Trading the moving average could also result in unrealized capital losses, and actual results may vary.
Ratings Score: Hold
In today's analysis, this stock won 3 of my 5 rating categories and is getting a hold rating. This is somewhat less bullish than the consensus ratings from SA analysis, Wall Street, and the SA quant system, as shown below, which all gave it a buy rating.
Sun Life - ratings consensus on Jul 22 (Seeking Alpha)
Risks to my Outlook: Asset Portfolio Exposure
As my rating is neutral & cautious, a risk to my outlook I have identified is that investors decide to avoid this stock due to concern over asset risk exposure on the company's books, thereby making my rating overly positive.
Due to the nature of its business model, much like many insurance companies I have recently covered, it invests a lot of its extra cash into an asset portfolio that generates income. This also poses risk for the company as well, depending what assets it is exposed to.
In recent months, there has been a lot of talk in media about the risk of exposure to commercial real estate and office properties, for example, and even an article in the Financial Times discussing how fund managers are reducing their exposure.
According to the article:
Fund managers have cut their allocations to commercial real estate to their lowest level since the 2008 global financial crisis, in the latest sign that investors are becoming concerned about the impact of rising interest rates and falling demand on the sector.
However, when taking a closer look at Sun Life's overall investment portfolio, which is worth a whopping $171.2B, it appears less than 6% is tied to investment properties and just under 9% tied to mortgages. The majority of the portfolio appears to be tied up in debt securities, typically fixed-income bonds and such.
Consider the following data from their Q1 presentation :
In their Q1 remarks, the company commented that they "reduced exposure to retail and office in recent years" when it comes to both investment properties and mortgages.
To drill down further, a breakdown of their mortgages held at the end of Q1 shows their majority property type being multi-family residential, with office being just 20% of their mortgage exposure:
Sun Life - mortgages by category (Sun Life - Q1 presentation)
In addition, their investment property breakdown shows that at the end of Q1 the largest property type they are exposed to is industrial, with office being closer to 26% of the portfolio.
Sun Life - investment properties by category (Sun Life - Q1 presentation)
Therefore, what I see here is a diversified portfolio of investments that is not overly exposed to office or commercial properties. However, since the Q2 figures are coming up in a few weeks, I would caution to wait on those to see if any key differences appear vs Q1. I expect the company to remain on the same trajectory of conservatively managing its portfolio and continuing to reduce exposure to office properties.
Analysis Wrap Up
Time to wrap up today's analysis, so here are the key points we discussed:
This stock is getting a hold rating, which is more cautious than the bullish consensus from Seeking Alpha and Wall Street.
Positive points about this stock include: dividends higher than sector average, positive YoY net income growth, capital & liquidity strength.
Headwinds facing the stock: share price is over 10% above its 200 day SMA, and the valuation is too high vs sector average.
A potential risk of this company is asset risk exposure in its investment portfolio, specifically commercial & office properties, however it has been addressed and revealed that such exposure is a minor part of their highly diversified portfolio.
In closing, I would say that holding a dividend-income stock like this could diversify a portfolio by gaining exposure to a Canada-based financial/insurance company like Sun Life, and one that is well established and has a large market share in its sector. For that reason, I am adding this stock to my watchlist however am holding out for a lower buy price, which could also increase the dividend yield even more.
For further details see:
A Sizzling 4% Dividend Yield At Sun Life, But Valuation Overheated