New York based is the largest life insurer in the U.S. and a leading provider of insurance, annuities, and retirement-savings products to individual and institutional customers.
MetLife (NYSE:MET), the largest life insurer in the U.S., is shifting its business mix to protection and other less capital-intensive products, which should result in less operating earnings volatility and improve free cash flow. The company has a diversified international platform, with the advantages of economies of scale and a well-known brand.
MetLife is also trading at a discount. The insurance company's shares have upside potential as interest rates rise, and interest rates are destined to increase as the economy improves. Finally, increased clarity on the looming FED regulation should also result in a higher P/E valuation.
After its acquisition of American Life Insurance Company from American International Group in 2010, which significantly expanded MetLife's international presence in Asia Pacific, Latin America, and Europe, it carried out a comprehensive strategic review of its business in 2012 that led the company to refocus its U.S. business, expand emerging market operations, and build a global employee benefits business.
The insurer is shifting its business mix to protection and other less capital-intensive products. The company's actions should not only result in less operating earnings volatility, but should also improve free cash flow.
Key drivers of the stock
While interest rates remain a key driver of insurance industry stocks, the regulatory developments continue to remain an overhang for MetLife shares. The company is in the final stage of consideration to be designated a systemically important financial institution (SIFI). As a reminder, American International Group and Prudential Financial were designated non-bank SIFIs by Financial Stability Council last year.
Other than interest rates and regulatory developments, several other business catalysts for MetLife are beginning to emerge. Sales growth in the U.S. is beginning to pick up, particularly in group and corporate benefit funding. International growth prospects post-2014 are also improving, there is increasing capital generation, and cost savings also remain on target. The year 2014 is one of transition for MetLife's earnings, and EPS growth should accelerate in 2015 and 2016.
Improving risk profile and free cash flow
MetLife is also taking measures to improve its risk profile and free cash flow (FCF). The insurer expects FCF to improve from 35% of operating earnings in 2014 to 45%-55% by 2015/2016 . Over time, MetLife's target is a ratio of more than 50%. This translates to roughly $2 billion-$3 billion of free cash flow in 2014 that is expected to be deployed, mostly for dividend increases and bolt-on mergers and acquisitions (M&As).
While the company's strategy to shift the business mix from market-sensitive, capital-intensive products toward protection-oriented, capital-efficient products will improve MetLife's risk profile, the strong free cash flow will provide management with greater capital management flexibility.
ROE target appears reasonable
MetLife's long-term (by 2016) core operating earnings growth target of 7%-8%, and ROE target of 12%-14% -- 11%-13% with no share buybacks -- appears reasonable vs. 12% in 2013. I think the company can achieve the low end of this target, even with the headwinds from low interest rates, and a slower than expected pace of capital return.
To achieve its 12%-14% ROE target by 2016, the company plans to repurchase $8 billion worth of shares by 2016, which should result in approximately 100bps of improvement in ROE. MetLife also assumes gradually rising interest rates. MetLife's earnings should improve further if interest rates rise, or if equity markets generate better performance.
Valuation has upside
MetLife's shares are cheap; the company is trading at just more than 9x its forward earnings, and 10% less than its book value. MetLife's valuation has potential upside if interest rates rise. Moreover, increased clarity on the looming FED regulation should also result in higher P/E valuation.
The company is well positioned to benefit from its diversified international platform. International sales and margins will be a major driver of the company's earnings going forward.
MetLife is trading at a forward P/E of 9.3, compared to 10.2 for American International Group, and 9.0 for Prudential Financial. The New York-based MetLife has a price/book ratio of 0.9 compared to 1.1 for Prudential Financial and 0.8 for American International Group.