It looks cheap on the surface, but I’m personally a little wary of Genworth MI Canada Inc. (TSX:MIC).
Even though the stock trades at a barely more than eight times earnings and is sitting right around book value, it’s just too exposed to Canada’s overheated real estate market for me to get out my chequebook.
For a worst case scenario, all investors need to do is look at what happened in the U.S. market back in 2008-09. Because of massive losses in mortgages, huge banks like Washington Mutual and Wachovia essentially blew up as losses from mortgages dwarfed the small amount of equity each company had on the balance sheet. It’s hard to handle much in losses when balance sheets are as stretched as they were back then.
The good news for Genworth Canada is the company has been able to closely study what went wrong with U.S. mortgages, and put itself in a position to learn from the disaster. In response, the company has done things like up its capital reserve requirements and stuff its investment portfolio full of low-risk bonds.
But these moves will only minimize the pain if Canada has a prolonged correction in housing. Areas like Toronto and Vancouver are especially at risk, as the value of real estate in both cities has outpaced the growth of income for years now, buoyed by decreasing interest rates, popularity of the sector, and a general distrust of the stock market after the financial crisis. These factors are leading many to call for a bubble, especially in Canada’s largest markets.
Bubble talk has been going on for years though, with many calling for the party to be over back in 2009-2010. Interest rates have also been predicted to go higher for years as well — which would (in theory, anyway) cause real estate to head lower — but rates have stayed stubbornly low, even as central bankers around the world try their best to stimulate the economy.
So I can see the bull argument for the stock. If Canada’s real estate market continues to do well, then Genworth Mortgage Canada should do well with it. And at just eight times earnings and a yield of nearly 5%, the value there looks pretty compelling.
Perhaps there’s a better option though. Here are the pros for investing in Genworth Financial Inc. (NYSE: GNW), the beleaguered parent of both Genworth Canada and Australia.
Why Genworth Financial?
Genworth Financial owns 57% of Genworth Mortgage Insurance in Canada, and 66% of Genworth Mortgage Insurance in Australia. Since both companies are publicly traded, it’s easy for us to figure out how much these stakes are worth, which is currently around US$2.5 billion. Currently, Genworth has a market cap of US$4 billion.
That means the market is valuing Genworth Financial’s life insurance, long-term care insurance, and U.S. mortgage insurance business at just $1.5 billion, even though these three divisions brought in more than $6.5 billion in revenue in 2014. Results were weighed down by the long-term care division, which management determined needed more in reserves. That led to a total loss of more than US$1.2 billion, or more than $2.20 per share. That’s a lot for a company trading near $8 per share.
But remember, these are mostly non-cash losses. Recent results have been much better as well, as the company reported a $0.30 per share profit in the first quarter. Annualized, that puts the company at less than seven times earnings.
Plus, the parent Genworth gets consistent dividends from its two subsidiaries, all without lifting a finger. There’s also the possibility of further selling off these stakes, freeing up capital to put into more attractive areas of the insurance sector. Or, as is widely speculated, Genworth Financial could sell the long-term care division, which has been the main cause of all of its woes.
Personally, I’m much more attracted to the parent Genworth, which trades at just a third of book value and has the ability to earn enough to put it at a small price-to-earnings multiple. Plus, it protects against Canada’s housing market, which will affect the share price of Genworth Mortgage Insurance much more than it’ll affect the parent.
