April 18, 2012

Genworth may generate weaker earnings than analysts expect

by Sridharan Raman

The financial sector of the S&P 500 dramatically outperformed the broader index during the first quarter, gaining 34% while the S&P 500 index advanced 12%. There are solid reasons for that stellar performance. Today, most U.S. banks can boast stronger balance sheet than they could only two years ago, now that they have improved their tier 1 capital ratios to meet strict new rules laid down by federal regulations. The recovery in banking stocks continued in the wake of announcements showing that most passed a new series of “stress tests” designed to measure their ability to weather another financial storm, as well as the ebbing of fears of a double dip recession in the US. All that has been good news for banks, which had been trading at levels that marked them as undervalued by historical measures.

Many of them also have been delivering positive earnings surprises to investors in recent days. But investors shouldn’t expect all the financial services companies to deliver robust earnings growth in 2012. In the current low interest rate-environment, companies associated with mortgage insurance as well as those that have a life insurance business are still likely to post weaker earnings than some analysts anticipate. Given that Genworth Financial (GNW.N) is involved in both these businesses, and that the company has a large negative Predicted Surprise of -6.7%, the StarMine research team has identified Genworth Financial as being likely to report first quarter earnings that fall short of the I/B/E/S consensus when it reports those results on May 1, 2012. This story the next in a series focusing on ten North American companies pinpointed by the research team as being among those most likely to either beat or miss estimates when they announce their quarterly results in the coming days and weeks.

Genworth’s poor earnings outlook stems from its business insuring residential mortgages both in the US and internationally. Although the mortgage delinquency rate in the US has finally started to fall, home prices are still declining, leaving a lot of the mortgages that Genworth had insured for their full value under water. As a result, Genworth has had to take reserve charges in the last six quarters and analysts expect the same will be true in the first quarter of 2012, which also saw a decline in the value of home prices; that will take a toll on its earnings. Both the SmartEstimate and the I/B/E/S consensus for the company have fallen since Genworth reported fourth-quarter earnings in February. The SmartEstimate currently stands at 24 cents a share, compared to the consensus of 25 cents a share. That lower SmartEstimate leads us to believe that the company will report earnings that fall below the consensus.

Genworth Financial also is a player in the life insurance market, which has been struggling amidst long-term interest rates that are among the lowest in the history of the business, as well as higher mortality rates. The company has a reputation among analysts for having one of the lowest premiums; given the low interest rate environment, the relatively low premiums means that they are under greater pressure to invest in riskier assets in order to generate enough income to ensure they can meet their obligations to policyholders. The Federal Reserve’s declared intent of keeping interest rates low for at least another two years is just another roadblock for Genworth’s ability to generate profits from its life insurance operations. (Of course, Genworth isn’t the only financial company to struggle with the impact of low interest rates on their operations; Charles Schwab (SCHW.N) has waived the fees on money market funds to ensure that clients don’t end up with negative yields, but the client-friendly move took a toll on its just-reported earnings.)

With its two main businesses under pressure in the short term, it’s not surprising that five of the six analysts who follow Genworth Financial have lowered their estimates for the company’s earnings since the beginning of February. The SmartEstimate for the rest of the year also is far below the consensus estimate for the same period, indicating that analysts don’t have much expectation of an earnings rebound any time soon. The negative Predicted Surprise for the quarter could be an early indicator that the company’s reported results may be a disappointment to investors when it reports its results in two weeks’ time.

SmartEstimates: Thomson Reuters StarMine Professional quantitatively analyzes the earnings estimate accuracy of sell-side analysts and uses this information to create proprietary SmartEstimates®. SmartEstimates help you better predict future earnings and analyst revisions with estimates that place more weight on recent forecasts by top-rated analysts.
Predicted Surprise %: The Predicted Surprise% is the percentage difference between the SmartEstimate and the I/B/E/S consensus estimate. When SmartEstimates diverge significantly from consensus, it serves as a leading indicator of the direction of future revisions and/or surprises. In aggregate, this indicator gets earnings surprises directionally correct 70% of the time.

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