MetLife Seems Seriously Underestimated

By Stephen D. Simpson, CFA | February 14, 2012 AAA

Even accepting that the credit crunch and recession changed a lot of views on just how strong even the best financial institutions actually are, it seems like MetLife (NYSE:MET) still carries too much doubt and skepticism with it. Granted, regulatory burden and low interest rates are certainly near-term challenges, but patient investors could reap outsized gains if and when MetLife can return to more normal performance.

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Pretty Solid Fourth Quarter Results
MetLife delivered a good end to the fiscal year. At the bottom-most of bottom lines, operating earnings came in at $1.31; not only up 15% from last year, but comfortably ahead of an average expectation of 1.24.

Overall premiums and fees rose 23%, with operating revenue up about 19%. With U.S. results mostly unchanged, this growth was driven by the incorporation of the AIG ALICO business.

MetLife reported operating earnings growth of 17%, with about 4% growth in the U.S. and 89% growth from international. "Core" results (which, for better or worse, are both non-GAAP and highly subjective to each analysts) were up about 34%, as the company saw 8% growth in the U.S. and 82% in international. By this core methodology, both U.S. insurance and corporate benefits saw high single-digit growth, while retirement rose by 11%.

Fighting Rates and Fighting the Fed
Low interest rates are certainly a challenge for insurance companies, and MetLife is no different. In the case of the annuities business (a large component of the retirement operations), strong year on year growth could be a risk factor; can MetLife deliver the returns it's advertising when the Fed is on record with its intention to maintain a low-rate environment for several years?

MetLife is also trying hard to reduce its regulatory burden. The company decided to shutter its retail mortgage origination business and sold most of its banking operations to General Electric (NYSE:GE) for a nominal amount. MetLife is trying very hard to not be a banking company and to avoid designation as a "Systemically Important Financial Institution" - a designation that puts it under closer regulatory scrutiny and may well impair its ability to distribute the capital it generates to shareholders. To wit, the Fed has already denied permission for the company to hike its dividend or launch a buyback pending a stress test in 2012. (For related reading, see How Buybacks Warp The Price-To-Book Ratio.)

Will Foreign Ops Separate the Company From the Pack?
There's a general perception that life insurance is low-or-no moat business. Perhaps that's true. Life insurance is fairly heavily regulated and perhaps most insurance buyers pay little attention to the underlying companies when choosing from among MetLife, Prudential (NYSE:PRU), Sun Life (NYSE:SLF) and so on.

That said, that's not true for all of MetLife's business. MetLife competes quite effectively with companies like Genworth (NYSE:GNW), Prudential and others, when it comes to large-scale corporate insurance, benefit and retirement contracts, and I would argue that's due in part to some real brand value and service differentiation.

An even bigger part of the MetLife story now rests on the international operations. The ALICO deal vaulted international to about 40% of the earnings base and I believe that competing with a few major international players (like Allianz and AXA) and a host of smaller local names will support better returns and growth for MetLife. If nothing else, there are many overseas markets where the populations are growing, seeing an improved quality of life and are under-served in insurance and retirement, relative to North America or Western Europe.

The Bottom Line
MetLife's present returns are below its pre-recession norms, but the current valuation seems to imply minimal improvement as time goes on. Not only does the stock look significantly undervalued by an excess returns model, the stock also trades for less than one times book - a meaningful discount to its pre-recession levels.

Should MetLife get tagged as a SIFI it is fair to assume that it will compress its potential returns on capital and its ability to share capital with shareholders. That said, even an assumption of regulatory deadweight leaves plenty of room in the model for these shares to outperform. Although interest rate risk and regulatory risk are still very real, and MetLife is not an especially exciting company, these shares are worth a serious look from value investors.

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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