Zacks Investment Research
Reinsurance Group of America Inc (NYSE: RGA) $42.86
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Overview
Headquartered in St. Louis, Reinsurance Group of America, Incorporated (RGA) is an insurance holding company that was formed on December 31, 1992 and provides primarily traditional life, asset-intensive and financial reinsurance. Its principal assets consist of the common stock of Reinsurance Company of Missouri, Inc. (RCM), RGA Reinsurance Company (Barbados) Ltd. (RGA Barbados), RGA Life Reinsurance Company of Canada (RGA Canada) and RGA Americas Reinsurance Company, Ltd. (RGA Americas), as well as investments in several other wholly-owned subsidiaries. RGA has subsidiaries, branch operations or representative offices in Australia, Barbados, Hong Kong, India, Ireland, Japan, Mexico, South Africa, South Korea, Spain, Taiwan and the United Kingdom. MetLife, Inc. is the beneficial owner of approximately 52 percent of RGA's outstanding shares. Its website is
The company’s fourth quarter results indicate that fundamentals in the life reinsurance business remain
favorable. RGA also appears well positioned to gain market share as many life reinsurers have exited the business. The company reported that mortality trends have improved in the US operations and that RGA’s international results have benefited from weakening of the US dollar over the past year. However, RGA’s international results could be negatively impacted if the dollar starts to strengthen. Fourth quarter EPS was impacted by several one-time items such as the Tsunami claims, Argentina Reserve Charge and benefit from the conversion of annuity contract. In the US division, the mortality rates have improved which is a significant positive for the stock. Analysts are divided in their opinion about the stock valuation. The analysts with a positive view on the stock believe that the core business fundamentals are strong and RGA has potential for strong top line and earnings growth in the upcoming quarters. However, some analysts have taken a neutral view on the stock since RGA is susceptible to fluctuating mortality rates and vagaries from the impact of the strengthening dollar. RGA on 3/7/05 announced that it has registered all of the 32.2 mm shares owned by MetLife (MET). Once the registration becomes effective, Met will have the flexibility to sell its remaining stake in RGA to the public. Majority of the analysts following the stock believe that a strategic sale is unlikely and expects the transaction will result in secondary sale to the public.
The company’s fiscal year ends in December and all quarterly and annual references are to be construed accordingly.
|Key Positive Arguments |Key Negative Arguments |
|RGA is no longer writing new policies or renewing existing ones for its |RGA’s international operations tend to be volatile on a quarterly basis. |
|Argentina business which involves reinsurance of pension operations( run off|Foreign growth could slow down if the dollar strengthens. |
|status for 2-3years) |RGA’s business in Asia, Europe and Africa could post volatile results in the|
|The life reinsurance market has consolidated in recent years as key players |upcoming quarters due to fluctuations in mortality and the small size of the|
|LNC, Allianz, GE and ING have divested their life reinsurance operations. |foreign operations. |
|RGA is reflecting solid fundamentals in its core business. |Asset intensive results in the US division have weak earnings potential in |
|RGA has successfully completed the acquisition of the life reinsurance |the upcoming quarters. |
|business of Allianz. |Financial rating agencies have indicated that if Met disposes off its stake |
|The price parameter is favorable to RGA’s operations at present. |in RGA through a secondary offering, they (Moody’s and S&P) may downgrade |
|U.S. mortality improvement is a key positive. |their rating of RGA. |
|Management has given premium growth guidance of 15-20% in FY 05. |Sustained low interest rates could affect the company’s ability to maintain |
|The sale of Met’s controlling stake is expected to increase the stock’s |spreads on some of their blocks of annuity business they reinsure. |
|liquidity in the upcoming quarters. | |
|The company is a leader in facultative life reinsurance in North America | |
|(primarily U.S. and Canada). | |
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Revenue
|Fiscal Year Ends: December 31, 2005|4Q04A |1Q05E |2Q05E |FY2004A |FY 2005E |FY2006E |
|$ In millions | | | | | | |
|US Operating Income |$78.0 |$74.0[pic] |$76.0[pic] |$291.0 |$312.0[pic] |$346.0[pic] |
|Canada Operating Income |$17.0 |$17.0[pic] |$16.0[pic] |$62.0 |$69.0[pic] |$77.0 |
|International Operating Income |$6.0 |$16.0 |$16.0 |$39.0 |$65.0 |$76.0 |
|Corporate |$(19.0) |$(11.0) [pic] |$(11.0) [pic] |$(48.0) |$(44.0) [pic]|$(48.0) [pic] |
The 4Q FY 04 pre tax operating income figure was $82 mm (9.68% YOY growth).
RGA uses a non-GAAP financial measure called operating income as a basis for analyzing financial results. Management believes that operating income, on a pre-tax and after-tax basis, better measures the ongoing profitability and underlying trends of the company's continuing operations, primarily because that measure excludes the effect of net realized capital gains and losses, as well as changes in the fair value of embedded derivatives and related deferred acquisition costs . Additionally, operating income excludes any net gain or loss from discontinued operations and the cumulative effect of any accounting changes, which management believes are not indicative of the company's ongoing operations.
RGA has been working in the facultative reinsurance market for several years. This provides RGA with competitive advantage in the North American market as the company is able to spread their risk over a much larger base which can help mitigate the impact of unfavorable mortality experience.
Fourth quarter operating results by segment follow:
US Operating Income:
The 4Q 04 US operating income was $78 mm (33.62% YOY growth). Premium growth declined 11% from the year ago quarter (4Q 03) since the earlier year included six months of premium from the Company’s transaction with Allianz.
Canada Operating Income:
The 4Q 04 pre tax operating income was $17mm (17.01% YOY growth).The fourth quarter included $1.6 mm pre tax provision for tsunami claims. Approximately $1.3 million of the increase in pre-tax operating income was the result of a favorable currency exchange rate. The U.S. dollar bottomed out at $1.18 against the Canadian dollar in late November, but has since risen more than 5%, bringing it close to a three-and-a-half month high. It inched up to about $1.24 on February 3rd 2005. In fact, the U.S. dollar could bounce between $1.20 and $1.25 against the Canadian dollar this year, and then rise to $1.29 by the end of 2006, according to a forecast by one analyst (RBC Capital Markets).
International Operating Income:
The 4Q 04 pre tax operating income was $ 6 mm (62.42% YOY decline). The decline can be attributed to $5.3 mm on account of Tsunami claims. In the fourth quarter, premium increased 18% YOY and the growth can be attributed to stronger foreign currencies. Expense ratios were also lower in the reporting segment as RGA gained economies of scale in its operations.
Corporate
The 4Q 04 loss figure was $19mm (35.97% YOY growth). The loss included $10 mm of pre tax reserve increase on account of the reinsurance of Argentina pension operations. The Company Management indicated that it expects the operation to be in a run off status for another 2 -3 years.
Please see the separately saved spreadsheet for more details
Earnings per Share
|Fiscal Year Ends: December 31, 2005 |4Q04A |1Q05E |2Q05E |FY2004A |FY 2005E |FY2006E |
|$ /share | | | | | | |
|Digest High |$0.87 |$0.98 |$1.01 |$3.57 |$4.11 |$4.55 |
|Digest Low |$0.87 |$0.94 |$0.97 |$3.57 |$4.00 |$4.42 |
|Digest Average |$0.87 |$0.95 |$0.99 |$3.57 |$4.06 |$4.51 |
|Zacks consensus |$0.87 |$0.95[pic] |$0.99[pic] |$3.57 |$4.06[pic] |$4.50[pic] |
Fourth quarter EPS was $0.87 compared to $0.85 in the year-earlier quarter (2.35% YOY growth).
Street Consensus was $0.95. Majority of the analysts had expected a higher 4Q 04 EPS figure. The difference can be attributed to a number of one time items: including Tsunami claims of $0.08 per share, a reserve increase for the Argentina business (reinsurance of pension obligations) which adversely impacted EPS by the amount of $0.10 per share. One analyst (UBS) believes that excluding unusual items 4Q 04 EPS would have been $1.03.
Management has projected FY 05 EPS guidance of $3.85 to $4.15 per share.
One analyst (Morgan Stanley) has increased their EPS estimate for FY 05 due to solid core earnings of RGA. However, the analyst (Morgan Stanley) believes that the sale of MetLife’s stake in RGA could weigh down on earnings in the forthcoming quarters. The analyst feels that the company may need to raise additional capital to operate on a standalone basis which may lower the projected EPS and Returns on Equity.
One analyst (Fox Pitt) believes that given the sustained low interest rate environment RGA will be challenged to increase its Return on Equity (ROE) over the next few years. The company’s targeted ROE is 12-14% for FY 05 and management has indicated that unless interest rates rise, potential investors should expect results to be near the low end of the range.
Please see the separately saved spreadsheet for more details.
Target Price/Valuation
The average target price for RGA is $51.25.
Of the analysts covering the stock, (44%) gave a positive rating to the stock and the remaining (56%) gave a neutral rating. For those analysts providing price targets, the range is $48 (FTN Midwest) to $54 (AG Edwards, Deutsche Bank). Both analysts with the highest target price (AG Edwards) rates the stock Buy; one values the shares on 12.5x 2006 estimated EPS of $4.30, while another values the shares on a 1.5x (ex FAS 115) book value of $36.36 (12/31/05). The analyst with the lowest target price (FTN Midwest) has a Buy rating on the stock and values the shares on a Price Earnings (P/E) basis.
The excel spreadsheet associated with this report contains a complete breakdown of ratings, price targets, and valuation methods by individual analysts.
| |
|Ratings Distribution |
|Positive |44% |
|Neutral |56% |
|Negative |0% |
|Average Price Objective |$51.25 |
|Number of Analysts |9 |
Risks to the target price objective are unfavorable mortality rates, and sensitivity to interest rates of RGA’s operations, low reinvestment rates, unfavorable developments in the asset intensive business, political and economic risk in international markets and changes in taxation.
Please see the separately saved spreadsheet for more details.
Long-Term Growth
The long-term growth rates for RGA fall within the range of 10% (Deutsche Bank) and 13.4% (FTN Midwest). Digest long-term growth rate is 11.6%.
Demand for reinsurance has increased and the industry is facing consolidation of key players which has positively impacted the price parameter for relevant players. The recent mergers (RGA/Allianz, Swiss Re/Lincoln Re, and Scottish/ING Re) have helped the existing players in terms of premium valuation.
Other Discussion Corporate Governance/Capital Structure/Cash Flow
The Company has received approval from the China Insurance Regulatory Commission (CIRC) to open a representative office in China, its eighth location in the Asia Pacific Region. Graham Watson, CEO of RGA's international operations highlighted that the China initiative will represent a key strategic component in RGA's international business plan and will be pivotal in the success of RGA’s ongoing global expansion.
One analyst (Fox Pitt) has highlighted the effect of the secondary offering of MET’s 52% ownership. The analyst feels that as premium prices decline in the Property & Casualty (P&C) market, many players could look to diversify into the life reinsurance space. This has led the analyst to believe that several property/casualty reinsurers could have interest in RGA.
RGA had $400 mm of long term debt outstanding at year end FY 04. RGA targets a debt/total capital ratio (including the redeemable preferred securities: PIERS in both the numerator and denominator) of 30%. At year-end FY 04, the debt/total capital ratio stood at 21.5%, implying about $300 million of incremental borrowing capacity. One analyst (Fox Pitt) believes that RGA is will utilize its debt capacity to fund growth in FY 06 and does not expect the company to issue primary shares until FY 07.
Individual Analyst
POSITIVE RATINGS
AG Edwards-Buy-($54) - report date 1/31/2005
The analyst expects 13% EPS growth over time and believes that the RGA shares will trade in line with the growth rate less a modest discount for the majority ownership by MetLife ,and will result in price target multiple of 12.5x in FY 05/06.
Deutsche Bank-Buy-($54)-report date-3/7/2005
The analyst believes that RGA has potential for stronger top line growth and the ability to sustain double digit earnings growth in FY 05. The analyst thus maintains a positive rating on the basis of strong fundamentals in the core business. The analyst also feels that demand supply fundamentals remain attractive in the life reinsurance business.
FTN Midwest Research-Buy-($48) - report date 1/28/2005
The analyst believes that the Company posted strong 4Q 04 results and maintains a positive rating on the stock.
Keefe Bruyette-Outperform-($53) - report date 1/31/2005
The analyst reiterates their Outperform rating based on the strong fundamental trends exhibited in the quarter and the attractive valuation.
NEUTRAL RATINGS
Fox Pitt-In-Line-($52) - report date-3/1/2005
The analyst believes that RGA is positioned to benefit from a strategic shift of negotiating power back to the reinsurers, and large scale of operations in the North American market. The analyst also feels that fundamentals in the life reinsurance market are improving and international operations are positioned to strengthen growth in the forthcoming quarters. However, the analyst expects some weakness in RGA’s shares in the near term due to the overhang associated with the potential secondary offering of MET’s 52% ownership.
J P Morgan-Neutral- report date 1/28/2005
The analyst believes that though fundamentals in the life reinsurance business remain favorable, volatility in the company’s results, owing to mortality fluctuations, remains one of the prime concerns. RGA’s international results should benefit if the U.S. dollar remains weak but would be adversely impacted if the dollar strengthens. According to the analyst, they would revise their outlook for the stock at an attractive valuation.
Lehman-Equal weight-($49) - report date 1/28/2005
The analyst believes that RGA has the ability to generate 15% EPS growth. However, the analyst feels that the Company’s ability to execute and achieve its earnings potential will depend on how RGA avoids the one time charges that were levied in 4Q 04. According to the analyst, RGA will need to post strong premium growth and stable claims ratio across all divisions and not just select areas to positively impact the stock in FY 05.
Morgan Stanley –Equal weight-($49) - report date 2/2/2005
The analyst believes that the future fundamental outlook is strong, with favorable pricing in the domestic sector, and strong organic growth opportunities in international markets. Though the core results in 4Q 04 supports the analyst’s fundamental view, it also highlights the more volatile nature of RGA’s results. The analyst recommends the investors to remain on the sidelines and wait for a better entry point. The analyst is more cautious on RGA because of the potential implications of the MetLife/Travelers Life and Annuity merger.
UBS-Neutral-($51)-report date 2/14/2005
The analyst has a less optimistic view of the growth prospects for the North American Life reinsurance market but assumes a FY 06 ROE of approximately 12%, thereby maintaining a neutral rating on the stock.
NEGATIVE RATINGS
There are no negative ratings on RGA shares at the present time.
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April 4, 2005
[pic]Research Digest Research Associate :Shalini Jindal,(MA,MBA)
Editor: Ian Madsen, MBA, CFA
imadsen@
Tel: 1-800-767-3771, x 417
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