Sun Life Has Approached Its Fair Value, Still A Solid Income Pick (NYSE:SLF)

Sun Life Financial (NYSE:SLF) is a Toronto, Canada-based multinational financial services firm with a significant vertical footprint in life insurance, group health insurance, wealth and asset management, and more across its geographic presence in North America, Europe, and Asia.

Through these activities, in Q3’23, Sun Life reported revenues of $6.01bn- a 3.32% YoY increase- alongside a net income of $655.13mn- an 86.17% increase- and a free cash flow of $1.77bn- a 35.23% decline attributable to reduced financing cash flows.

Since my last article, Sun Life has seen a total net return of 7.09%, approaching ATHs but also representing slowed growth relative to the market. This has manifested many of Sun Life’s diverging realities, as their operational story deserves a premium over peers, though the said premium may now be priced in.

Introduction

At its core, Sun Life operates through its four strategic pillars, holistically including its asset management presence- with particular success across wealth management and mutual funds- its traditional life and health insurance businesses in Canada, stop-gap and dental health insurance in the US, and diversified vertical growth across Asian markets.

Although Sun Life may have met or may even exceed my revised fair value estimates, I believe that the firm’s superior corporate strategy balances the company’s growth trajectory. As such, although I downgrade Sun Life to a ‘hold’ I would not be surprised to see long-run growth outpacing peers.

Valuation & Financials

Trailing Year Price Action

In the TTM period, Sun Life’s stock- up 5.37%- has seen poorer price action to both TradingView’s Insurance Index- up 7.63%- and the broader market, as represented by the S&P 500 (SPY)- up 20.08%.

The general insurance industry’s underperformance can be chalked up to higher interest rates, which devalued the industry’s extant, long-term bond-heavy portfolios and therefore the industry’s price action.

Sun Life, which had not declined as much as the industry previously, did not see the same growth due to outsized prior growth nudging to fair value earlier.

Comparable Companies

Since I have covered Sun Life before, and Canadian peers generally operate within similar regulatory and financial boundaries, I sought to compare Sun Life to previously compared Canadian insurers. This group includes the Toronto, Ontario-based largest insurer in Canada, Manulife Financial (MFC), the Montreal, Quebec-based financial services conglomerate, the Power Corporation of Canada (POW.TO), and the Toronto, Ontario-based P&C and auto insurer, Intact Financial (IFC.TO).

As demonstrated above, over the past quarter, Sun Life has seen middling price performance relative to peers. This seems to, alongside Sun Life’s multiples and growth statistics, indicate the firm’s approach towards its fair value.

For instance, Sun Life maintains the second-best trailing and third-best forward P/E ratios, alongside the second-best PEG ratio. Additionally, the insurer sees the second-best P/S, third-best P/CF, and third-best P/B; this demonstrates Sun Life’s average comparative positioning across all financial statements, and general equivalence with fair value.

Moreover, when assessing growth statistics, while Sun Life is above average- demonstrating the firm’s superior operational capabilities- the firm is no longer exceptional, with the best ROE but only the second-best ROA.

Another key factor for investors should be Sun Life’s solid 4.34% dividend off of an extremely sustainable 47.14% payout ratio. Seeking Alpha’s dividend report card is also solid for Sun Life:

Valuation

According to my discounted cash flow valuation, at its base case, the net present value of Sun Life Financial should be $53.01, meaning that at its current price of $50.98, the stock is undervalued by 4%.

My model, calculated over 5 years without perpetual growth built-in, assumes a discount rate of 9%, balancing a higher general cost of capital with Sun Life’s lower cost of equity. Remaining conservative, I assumed a forward 5Y revenue growth rate of 6%, lower than the trailing 5Y arithmetic average of 6.63%.

Alpha Spread’s multiples-based relative valuation tool, on the other hand, estimates an overvaluation of 20%, representing a relative value of $41.03.

As such, taking an average of my NPV and Alpha Spread’s valuation the fair value of Sun Life should be $47.02, representing an overvaluation of ~8%.

Continued Scale & Margin Growth Strategies Outpace Peers

An understated strategy Sun Life has extensively committed itself to in the third quarter. This transition has taken place across multiple verticals, from extended health coverage for Canadians to expansions into teledentistry in the US and becoming a leader in virtual insurance in Hong Kong. This growth has not been entirely organic, with Sun Life recently completing its acquisition of Dialogue Health Technologies.

The firm also retains a superior strategic positioning to peers in relevant distribution capabilities. For instance, in Sun Life’s asset management segment, Sun Life distributes its products through retail intermediaries and direct, acquired affiliates. Or, more customized for the market, in Asia, Sun Life supports a sustained pipeline of >97,000 agents, developing bancassurance and mutual fund operations in the area.

These strategies have ultimately supported a strong financial base, with highly diversified income streams- a far cry from Sun Life’s near absolute dependence on life insurance a decade ago. With a low financial leverage ratio of 21.8% and >$1.4bn in holding company cash, Sun Life is well-positioned to adapt to ever-changing environments.

Wall Street Consensus

Analysts are more positive about the stock than I am, estimating a 1Y price target of $55.00, a 7.89% increase.

At the minimum projected price target, however, analysts generally echo my sentiment, projecting a price of $49.42, a 3.06% decline.

I believe the analyst sentiment pricing the company above my aggregate valuation is supported by the premium of the company’s operational model.

Risks & Challenges

Rate Sensitivity May Disadvantage Sun Life Either Way

Although Sun Life is well-positioned financially, the company is particularly sensitive to any volatility in rates; if rates go up, the firm’s existing portfolio sees reductions in value. If rates go down, income from bonds is reduced. As such, unless rates are sticky, Sun Life may see reduced income or downstream demand for its products due to rate sensitivity.

Regulatory Complexity May Increase General Compliance Costs

Sun Life’s aggressive operational expansion across different geographies and segmentations, while supporting margin and scale expansion may increase the level of regulatory complexity, in turn potentially increasing compliance costs. This may then reduce Sun Life’s ability to expand and negate any operational premium deserved by the company.

Conclusion

Looking forward, Sun Life, although operationally superior to peers, trades at fair value and thus should be seen as a solid income pick above all else.