Great-West Lifeco: Strong Results But Shares Are Overextended

Please note all $ figures are in $CAD, not $USD, unless otherwise stated.

Introduction

I recently covered Power Corporation (POW:CA), the parent company that owns almost 70% of Great-West Lifeco (TSX:GWO:CA). In this article, I’ll discuss Great-West Lifeco, one of its largest public investments, and delve deeper into the business and its most recent earnings results to assess its financial prospects going forward.

Company Overview

If you haven’t heard of Great-West Lifeco, the company is a major financial services company in Canada with various interests in insurance, investment services, asset management, and reinsurance. Under the Canada Life, Empower, and Irish Life banners, its geographical reach spans both North America and Europe.

Over the last few years, the company has been undergoing both acquisitions and divestments to reposition its portfolio. For example, last year, it bought Prudential Financial retirement business through its Empower division to grow its retirement portfolio and earlier this year, through Canada Life, it purchased Value Partners and acquired Investment Planning Council to grow its exposure to wealth management. On the divestment side, in May 2023, it sold its Putnam Investments division to Franklin Templeton (BEN) in a transaction worth US$1.7-1.8 billion, which included Great-West Lifeco getting almost 5% of the outstanding shares in Franklin Templeton stock.

Most Recent Results

As is typical for many of the major financial services companies in Canada, Great-West Lifeco reports consistent numbers quarter-to-quarter, and its latest results were no different.

In the most recent quarter, the company announced record base earnings per share of $1.02 which was 17% higher than last year’s Q3. Most of the reason for the increase was that the company’s US base earnings doing well with higher fee income and spread income, along with synergies from the Prudential deal.

I view the results as very strong, given that the base ROE improved to 17% and that the company’s book value per share increased 5% year over year. This indicates that the company is becoming more profitable, more efficient, and is increasing the overall net worth of the company.

When we look deeper into the segments, the notable standout is the Wealth & Asset Management division. Through Empower Personal Wealth, which was launched after the existing retail and Individual Retirement Account business was merged with Personal Capital, the company saw 30% growth in assets under management and 23% growth in its client base just one year after launching last January.

In my view, with Great-West Lifeco’s increased focus into wealth and retirement, this strong growth in Empower Personal Wealth seems very much aligned with their strategy. After a weak year for equity markets in 2022, many investors and retirees and benefitting from the new interest rate environment with higher savings rates and equities outperforming in 2023. The increased wealth in the economy has also meant that the need for retirement plans and other forms of financial services has increased. This all bodes well for Great-West Lifeco.

Moving over to the Workplace Solutions segment, an area that management wants to increase from 45% of base revenues to 50% of base revenues by 2027, the company has been reporting strong growth in all three markets of Canada, the United States, and Europe. In Canada, premiums for the Group Life & Health premiums grew 23% from last year, through a combination of good organic growth and through new enrollments under the Public Service Health Care Plan, which is a supplementary plan for federal government employees and their dependents. As the sole administrator of the plan, through Canada Life, the company has enrolled over 1.68 million of the 1.7 million individuals who are eligible to access benefits. In Europe, we saw similar results, with premiums for the Group Life & Health book increasing 18% and assets under administration up 17%. So Europe and Canada are looking pretty good.

However, in the US under Empower Defined Contribution, despite assets under administration increasing 14% and the number of those enrolled in the plan up 4%, it did see some net outflows this quarter that could look concerning. On the earnings call, management discussed that the $6.6 billion of outflows were as a result of the acquisition and still retained around 85% post-acquisition.

This was a weak area of their results so I believe there may be some attrition going forward that translates to lower assets under administration growth. Once the acquisition is fully integrated, the outflows will likely drop down a lot, but this is still an area to watch for in the quarters to follow. I still think Empower has room for base earnings growth as the company mentioned they are still on track for $180 million of pre-tax synergies with a run-rate of 66% up to the quarter end, with a full run rate of those cost synergies starting in the second half of calendar 2024.

In terms of the risks going forward, since Great-West Lifeco operates internationally but reports in Canadian dollars, any appreciation in the Canadian dollar relative to the currencies of the countries in operates in would have an adverse impact on the company’s earnings. At the corporate level, it doesn’t use any hedges or swaps to protect against currency fluctuations. Another risk would be if the overall macroeconomic environment were to deteriorate. As a financial services company, Great-West Lifeco has been benefitting from the recent recovery in equity markets, and so any sort of negative movements could impact their earnings and profitability. Finally, looking at the company’s credit ratings below, Great-West Lifeco has AA ratings from most of the large rating agencies, indicating the company seems to be in good overall economic health with sufficient cash flow to maintain its current credit.

Valuation

Based on the 4 equity research analysts with a one-year target price on Great-West Lifeco, the average target price is $42.00, with a high estimate of $44.00 and a low estimate of $40.00. From the average price target of $42.00, this suggests about a 4% downside from the current price so the company looks to be temporarily overvalued based on analyst estimates.

With a book value of a little over $24 a share, shares are trading at a pretty big premium at around 81%. Even though the book value increased about 5%, shares are up about 14% since last quarter. That said, unlike in valuing Power Corporation, which is more of a holding company with much more insurance exposure, I’m not sure book value is the best way to value Great-West Lifeco. Valuing it on its earnings power at about 10.1x earnings (or 9.4x forward earnings), the company’s shares certainly don’t look to be overly expensive.

Shares currently pay $2.08 in dividends annually for about a 4.8% yield. With around $3.88 in EPS for the full year 2023 (S&P Capital IQ), the payout ratio is a little over its historical average at around 53.6%, at the upper bound of management’s target payout ratio of between 45-55% of earnings. Given this, I foresee limited dividend increases going forward.

When comparing Great-West Lifeco to its peers like Manulife (MFC:CA) and iA Financial (IAG:CA) at 6.9x and 8.5x forward earnings, respectively, shares look a bit overvalued at 9.4x forward. That said, Great-West Lifeco has more wealth management exposure which gives it a higher premium, a premium which has historically been around 12% over the last five years.

With shares having run up substantially higher than its peers and the valuation disconnect being much larger, I’d be inclined to wait for a pullback before buying shares of Great-West Lifeco. For my target, that would be around the $38 mark, which would imply a premium closer to the 12% range and also imply a dividend yield of 5.5%. So while I love the business and would like to be a shareholder, for now, I’ll be watching carefully to see if shares reach this area and would consider taking a position around those levels.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.