MetLife's Guidance Reflects A Wider Problem

By Stephen D. Simpson, CFA | December 13, 2012 AAA

For readers who think that the United States government bends over backwards to accommodate the financial industry, MetLife's (NYSE:MET) discussion of guidance for the remainder of 2012 and 2013 is a must-read. While the troubled asset relief program and a variety of other government programs clearly allowed financial companies to shore up their capital, the reality is that the zero interest rate policy and "QE infinity" are taking a toll on companies that earn their living on interest rate spreads.

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A Tough 2013 Is Coming
MetLife announced guidance for 2013 that was well below prior analyst estimates. Against the prior average estimate of $5.51 in 2013 earnings per share (EPS), MetLife management announced that they expect operating earnings to be more on the order $5.15 (with a range of $4.95 to $5.35).

A key factor in this lower guidance was the outlook for interest rates, not to mention substantially lower variable annuity sales. Although MetLife was already in solid shape relative to other insurance companies like Prudential (NYSE:PRU) and Lincoln National (NYSE:LNC) in terms of variable annuity exposure, management is nevertheless pulling back and expects significantly lower sales in 2013. While this will have a negative near-term earnings impact, it may actually be better for longer term returns on equity.

Perhaps more troubling is that it would seem that MetLife won't be generating much, if any, excess capital in 2013. Not only does that mitigate the potential for dividend hikes and share buybacks, but it may also reflect the overall higher levels of capital that the company will have to maintain in the future.

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Maybe 2013 Won't Be so Bad, After All ...
Investors should note that MetLife is, by and large, an "under-promise and over-deliver" sort of company, so there is at least a reasonable chance that actual results will not be as bad as forecasted. In particular, it's worth noting that about a third of the company's business comes from overseas markets that are not as sensitive to U.S. interest rate policies. It's also worth noting that the company's 5% target for the S&P 500 could prove to be conservative, and my math suggests a roughly 3 cents to six cents EPS impact for every 1% deviation.

That said, there are some significant risks here. If rates stay as low as they are now, for an extended period of time (say for or five years), MetLife will likely be hard-pressed to grow much beyond the low-single digits. Like as not, though, ongoing low rates in the U.S. will spur the company to make additional acquisitions overseas, particularly in emerging markets.

It's also worth noting that MetLife's regulatory situation may not improve as quickly (or as much) as hoped. The company's sale of banking assets to General Electric (NYSE:GE) is basically done, and the company should be able to drop its bank status in the first half of 2013. Even still, though, the company is likely going to remain a systematically important financial institution and subject to more serious regulations. If the regulatory burden gets too high, though, I wouldn't be surprised to see the company pursue a breakup strategy.

SEE: Use Breakup Value To Find Undervalued Companies

Not Just a MetLife Problem
I don't mean to suggest that every financial company has the same interest rate risk or exposures as MetLife, but the reality is that there are a host of financial companies that make a sizable percentage of their earnings from healthy interest rate spreads. Although banks like U.S. Bancorp (NYSE:USB) have extensive fee-based business interests that are much less rate-sensitive, banks like Zions Bancorp (Nasdaq:ZION) are much more dependent on net interest income.

Likewise, it's not just life insurance companies that depend upon healthy rates. Most property and casualty insurers subsist on thin underwriting ratios, making the interest they earn on their portfolios an important factor in their overall earnings. Consequently, companies like Allstate (NYSE:ALL) and Progressive (NYSE:PGR) are also going to see ongoing pressure from the low rates.

The Bottom Line
These are not easy days for MetLife, but I continue to believe that the market underestimates this company's long-term earnings power. Even if low rates and new regulations put the company's former returns on equity out of reach, I believe the company is fundamentally undervalued on the basis of what I believe it can earn off its capital. Trading at just about half of its book value, I'd be a buyer of MetLife, even if low rates are going to crimp growth for the next year or two.

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

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