Genworth Financial (GNW 4.63%) is an interesting and extremely undervalued insurance company that appears to have solid appreciation potential.
This business gives investors exposure to both a fairly stable life insurance business and a more volatile global mortgage unit. That latter unit could drive Genworth Financial's valuation going forward if the U.S. housing market continues to recover.
In fact, given Genworth Financial's high reliance on its international mortgage division, the company should do reasonably well in an environment of rising interest rates, higher real estate prices, and higher mortgage insurance demand from homebuyers in the United States and abroad.
Diversified business model with upside potential
Genworth Financial's operations encompass its U.S. life insurance segment, which includes long-term care insurance, life insurance, and fixed annuities. Then there is the mortgage insurance unit with sizable exposure to the U.S., Australian, and Canadian real estate markets.
Genworth Financial's increasing focus on long-term care insurance is a big positive for shareholders. This particular service line has constantly increased its importance over the last year.
In the first quarter of 2013, long-term care insurance contributed only $20 million of net operating income, or 24%; in the first quarter of this year, that rose to $46 million (a year-over-year increase of 130%), or 49% of total first-quarter 2014 net operating income of $94 million.
While the life insurance business provides a fairly stable premium flow and also captures new insurance trends such as long-term care insurance, I believe Genworth Financial's mortgage unit is where a lot of hidden value lies.
The Australian and Canadian real estate markets have been doing fairly well for investors and homebuyers over the last couple of years. As such, it should be no surprise that these two markets are true earnings drivers for Genworth Financial.
The international mortgage division contributed 68% of Genworth's first-quarter net operating income, and I believe this percentage could actually increase going forward if U.S. mortgage demand bounces upward.
Mortgage demand is likely going to grow in a period of cyclically rising interest rates, when homebuyers feel it is more advantageous to leverage up sooner rather than later.
The chart to the right depicts the development of Genworth Financial's net operating income in its mortgage division over the last five quarters.
The main takeaway: The United States is becoming in increasingly attractive net operating income contributor for the insurance company.
While the Canadian and Australian real estate markets provide relative high, stable income for Genworth, the United States contributed a much higher share of 25% of total first-quarter 2014 net operating income, compared to the fourth quarter of 2013 which saw only a 6% NOI contribution from the U.S.
Of course, mortgage insurance businesses didn't have it easy post-2008. But many insurance companies have restructured their businesses, reduced risk, and raised capital.
This transformational period in the private mortgage insurance sector has deeply unsettled investors, the majority of whom are still focusing more on the past than on the future. Genworth Financial is no different here.
Compared against other mortgage insurance companies Radian Group (RDN 1.71%) and MGIC Investment (MTG 2.37%), Genworth certainly looks appealing on price-to-book valuation.
With less exposure to mortgages than its immediate mortgage insurance peers - due to its focus on its U.S. life insurance business - Genworth Financial trades at a meaningfully lower price-to-book value of only 0.53 times.
However, as demonstrated above, Genworth still has significant exposure to the mortgage insurance sector and so should trade at a much higher book multiple.
The Foolish takeaway
Genworth Financial is an interesting insurance business with an attractive mortgage division, which lends the company an international profile and gives it sizable exposure to strong real estate markets abroad.
The insurance company trades cheaply compared to its book value and should do very well in an environment of increasing interest rates and higher mortgage insurance demand.