Putnam will pay off for Great-West

GREAT-WEST LIFECO INC. $24 (Toronto symbol GWO; Conservative Growth Portfolio, Finance sector; Shares outstanding: 944.7 million; Market cap: $22.7 billion; Price-to-sales ratio: 0.7; Dividend yield: 5.1%; SI Rating: Above Average) is Canada’s largest insurance company, with $340.7 billion of assets under management. It also offers retirement planning and wealth-management services. Power Corp. owns 68.7% of Great-West’s shares. The company gets 50% of its earnings from Canada, followed by Europe (30%) and the U.S. (20%).

Great-West’s revenue rose 171.4%, from $28.2 billion in 2004 to $76.5 billion in 2008. Earnings rose from $1.50 a share (or a total of $1.2 billion) in 2004 to $2.26 a share (or $2.0 billion) in 2008.

Putnam purchase behind gains

In August 2007, Great-West paid $4.7 billion U.S. for Putnam Investments Trust, a leading U.S. mutual-fund company. Putnam was the main reason behind Great-West’s recent gains. The purchase increases Great-West’s stock-market exposure, but the company can now sell its insurance products to Putnam’s large client base.

The stock market downturn in late 2008 and early 2009 increased Putnam’s fund redemptions, and cut the value of its remaining assets. This hurt Putnam’s earnings, since its fees rise and fall with the value of the securities in its funds.

However, Putnam is benefiting from rising stock markets. It has also launched new products that have slowed its redemptions. These include its “Absolute Return” mutual funds, which aim to deliver a specified return instead of beating an index. In the three months ended September 30, 2009, Putnam’s fund outflow improved to $2 billion from $3.5 billion a year earlier. It now administers $121.5 billion of mutual funds and other assets.

Great-West invests the premiums it receives from its insurance policies in a wide variety of securities. Income from this portfolio helps it pay out insurance claims.

Impact of future writedowns is small

Because of last year’s financial-market turmoil, Great-West had to set aside more cash to cover potential writedowns of the securities it holds. These include bonds issued by Royal Bank of Scotland and Lloyds Banking Group, both of which received assistance from the U.K. government. The book value of these bonds exceeds their market value by $372 million. Great-West has already set aside $306 million, so any further writedowns would have only a small impact on future earnings.

Strong balance sheet cuts risk

In late 2008, Great-West sold $1 billion of common shares and $230 million of preferred shares to shore up its already strong balance sheet. This will help it absorb potential losses on its securities, and possibly buy other financial-services firms

The stock has more than doubled from its March 2009 low of $11.21. Despite this gain, it still trades at a reasonable 13.9 times the $1.73 a share that Great-West will probably earn in 2009.

Great-West Lifeco is a buy.