Buy These Two, Avoid the Parent

Holding companies tend to trade for less than the value of their various pieces (‘holding company discount’). Still, despite the apparent bargain, we only recommend the holding company over its subsidiaries when we have a high opinion of all the subsidiaries. A good example is our longtime favourite Canadian Pacific Ltd. When it broke itself up into five new companies in 2001, we saw all of the new stocks as buys.

Power Corp., Toronto symbol POW, through subsidiary Power Financial Corp., Toronto symbol PWF, currently controls two of our long-time recommendations: Great-West Lifeco Inc. and IGM Financial Inc.

However, Power Financial also holds several European companies. We feel that weaker economic conditions in Europe expose Power Financial investors to more risk than either Great-West or IGM. Conservative investors are better off with these two instead of the parent. Both offer value, income and an excellent way to diversify the Finance sector of your portfolio.

GREAT-WEST LIFECO INC. $28 (Toronto symbol GWO; Conservative Growth Portfolio, Finance sector; SI Rating: Above average) is one of Canada’s largest insurance companies, with $191.3 billion in assets under administration. It sells its insurance products directly and through brokers to both individuals and groups. Power Financial controls about 75% of Great-West.

The company also provides wealth management and other financial services. Great-West gets roughly 50% of its profit from Canada, 30% from the U.S. and 20% from Europe.

Great-West’s revenues rose from $16.1 billion in 2001 to $23.9 billion in 2005, or 10.4% compounded annually. Much of that growth is due to Great-West’s 2003 purchase of rival Canada Life Financial Corp. for $7.2 billion in cash and stock.

Consequently, profits rose at a compounded annual rate of 29.4%, from $0.70 a share (total $515 million) in 2001 to $1.96 a share ($1.8 billion) in 2005.

In the three months ended June 30, 2006, earnings before unusual items rose 2.0%, to $0.51 a share (total $475 million) from $0.50 a share ($453 million) a year earlier. Revenue grew 15.8%, to $6.6 billion from $5.7 billion.

New computers improve efficiency

Investments in new computers hindered the company’s profit growth in the latest quarter. But these investments should improve Great-West’s efficiency, and cut its operating costs.

The rising Canadian dollar also hurt its growth. In fact, on a constant currency basis, per-share earnings would have grown 11% in the second quarter.

The company is now looking to the U.S. and Europe to spur long-term growth, mainly through small acquisitions. For example, it recently agreed to administer 2,600 small and mid-sized pension plans in the U.S., and purchased part of the annuity business of a leading UK insurance company.

These moves strengthen Great-West’s share of these niche markets, and expanded its salesforce. That gives it more opportunities to sell its new clients other products and services.

The company also earns income based on the value of the securities it manages. Raising its fee-based income cuts its exposure to volatile stock markets.

Stock buybacks cut dilution

Great-West is an aggressive buyer of its own stock. That helps offset the dilution caused by its stock option plans.

It spent $57 million on buybacks in 2005, and $30 million more in the first half of 2006.

The company has a lengthy history of increasing its dividend every six months. It recently raised the quarterly payout 7.3%, from $0.22375 to $0.24. The new annual rate of $0.96 yields 3.4%.

The stock has stayed in a narrow range for the past two years. It now trades at 13.1 times the $2.13 a share it will probably earn in 2006.

Great-West Lifeco is a buy.

IGM FINANCIAL INC. $47 (Toronto symbol IGM; Conservative Growth Portfolio, Finance sector; SI Rating: Above average) is Canada’s largest mutual fund company, with $103.7 billion in assets under management.

It also offers retirement planning and other investment services. Power Financial controls roughly 55% of IGM’s stock.

IGM has two main subsidiaries. Investors Group sells its products through its own network of 3,600 financial advisors. Mackenzie Financial sells its funds through independent brokers.

The company also owns 74.7% of Investment Planning Counsel Inc. (IPC), whose 540 advisors provide a range of wealth management services. Although IPC owns the Counsel Group of mutual funds, it also sells Investors Group and Mackenzie funds to its clients.

Revenue up 47% in five years

IGM’s revenue rose from $1.6 billion in 2001 to $1.9 billion in 2002. Revenue slipped to $1.87 billion in 2003, but climbed to $2.35 billion in 2005. Earnings before non-recurring items rose from $1.58 a share (total $392.6 million) in 2001 to $2.56 a share ($682.4 million) in 2005, or 12.8% compounded annually.

In the second quarter of 2006, IGM’s profits grew 19.0%, to $0.75 a share (total $200.4 million) from $0.63 a share ($167.9 million) a year earlier. Revenue rose 9.9%, to $636.6 million from $579.2 million.

IGM sells mutual funds and other investments mainly to individuals. It now wants to broaden its client base to include more institutions and high net worth investors. Consequently, it has agreed to buy privately held Cundill Investment Research Ltd. for an undisclosed sum.

Mackenzie Financial acquired Cundill’s retail mutual fund operations eight years ago, and Cundill still helps it manage these funds. This familiarity should cut the risk that always comes with integrating new operations.

Like Great-West, IGM has a long history of dividend increases. The current annual rate of $1.59 a share yields 3.4%.

The stock hit an all-time high of $54 in April 2006, but still trades at a reasonable 16.5 times its likely 2006 profit of $2.85 a share.

IGM Financial is a buy.