iA Financial Stock: Exceeding ROE Target, Expect Accelerated EPS Growth Ahead (TSX:IAG:CA)

Introduction

I last covered iA Financial (TSX:IAG:CA) in January and since then shares have delivered a total return of 6.9% while the S&P500 has returned 8.0%. Despite some underperformance in the share price, I’ve become even more bullish on the company since then, especially after an impressive second quarter. During the quarter, the company blasted through its 15% ROE target and also had 40%+ growth in Seg funds. In this article, I’ll unpack the latest results and explain why I’ve become even more optimistic on iA Financials’ stock.

Company Overview

iA Financial is a Canadian financial services company with primary operations in insurance. With roots that date back to being a primarily Quebec insurer, life insurance and health insurance solutions are still the company’s main business. Over time, the company gradually added other forms of insurance to its offering including disability insurance, car insurance, home insurance, and travel insurance. In an effort to diversify and target faster growing markets, iA Financial has gradually become more involved in wealth management and retirement planning. It’s also got some U.S. operations that make up about 15% of the company’s earnings. With nearly $230 billion in assets under management, the company employs 9500 people and has over 50,000 advisors.

Q2’24 Results

When looking at iA Financial’s latest results for the second quarter, the company reported core EPS of $2.75, up 15% year over year, reflecting a 6% decline in share count, higher CSM amortization, and stronger WM results, partially offset by lower investment income. Compared to analyst estimates, EPS came in ahead of consensus estimates of $2.54 (source: S&P Capital IQ). Most of the reason for this was due to a lower effective tax rate and better wealth management results.

On the top line, Canada individual and group insurance sales were both up 10% year over year (without drawing a spike in strain), while P&C sales were up 15% compared to last year as the market stayed firm. In the U.S. dealer services business, revenues were up 15% against the year prior on improved distribution and higher vehicle inventories. While I think it should be noted that the CDK outage had an impact on results, the impact was modest and temporary.

For U.S. insurance sales, results came in at a record pace in Q2’24, which is great to see in my view as this has been an area the company had previously been allocating resources to given better growth. In the wealth management segment, I think one of the biggest highlights from the quarter was on the segregated (Seg) funds side, which was up a whopping 45% year over year, despite mutual funds remaining in outflows of $194 million.

In my view, one of the biggest standouts this quarter was on ROE. During the quarter, while book value per share came in up 1% sequentially and 9% year over year (excluding the impact of buybacks), core ROE clocked in at 15.9%, above the targeted ROE of 15% for the first time.

Given these results, it seems that the company is firing on all cylinders. In my view, we should expect further improvement in the U.S. Dealer Services businesses over time with the inventory situation easing. On the earnings call, management noted that ROE has potential to in the high teens. For now, it’sit’ still maintaining the 15% formal target, but similar to peers, the company could possibly move to 17-18% over time, like a Manulife (MFC:CA), for example. Looking at the other ratios, I think LICAT remains strong, the leverage ratio (16.4%) is low, and excess capital stands at $1.1 billion, versus $1.5 billion last year, before the Vericity acquisition.

Outlook

In terms of my outlook going forward, I fully expect management to revise the long-term target ROE to above 15%. Based on the share price reaction following the quarter, I don’t think the market is given iA Financial enough credit for the progress the company has been making on this front. In previous quarters, there were concerns about taking on premiums for the sake of growth at the expense of profitability and margins, but it seems that iA now has its priorities on track. Assuming peers play ball, I think ROEs in this business have a chance to be structurally higher in the next few years than they’ve been previously, which is one of the big reasons I’ve become more bullish on iA.

Regarding the individual segments outlook, I think it’s business as usual for iA and Q3’24 and Q4’24 should follow a similar trajectory.

For the Canada insurance operations, the company seems to be benefitting from lower auto and home claims along with higher premiums, and favorable mortality experience in group and individual insurance. With this being the third consecutive quarter of better mortality, particularly after weak results in 2023, I’m expecting continued strength. So far, higher group insurance sales did not cause high strain. Strain improved slightly year over year and quarter of quarter. The strain should accrue to the benefit of future earnings through ongoing renewals of contracts, in my view.

In U.S. operations, on the earnings call, management commented that it’s focused on expense management to drive margin improvement. Cost cutting and pricing should drive better results in U.S. dealer services later in second half of the year and so I would say that there’s a good chance of continued recovery in the U.S. dealer services in FY’24 as affordability improves. This quarter, sales continued to improve as vehicle inventories grew which is a positive indication.

Risks

An investment in iA Financial is note without risk. As an insurance company, interest rate risk is the primary source of risk to the company, in my view. Any material deterioration in the economy, credit conditions, and narrowing of spreads would be a negative headwind for the company. If interest rates are to go down dramatically lower over the next few years, the company’s insurance operations would likely have come impact.

Other risks to the investment thesis include company specific risks like iA Financial undertaking a sizeable acquisition in the U.S. (if it uses too much leverage or can’t generate enough synergies), potential for increased competitive pressure, unexpected spikes in claims activity, or potential regulatory investigations into sales practices. So far, we’ve seen no evidence of these things so I prefer not to worry about these types things. Nevertheless, it’s important to be aware of the risks and monitor these risks over time to ensure the company is on the right track.

Valuation and Wrap Up

Based on the 8 sellside analysts who cover iA Financial’s stock, there are 7 ‘buy’ ratings and 1 ‘hold’ rating with an average target price of $107.25. From the current price to the average price target one year out, this implies about 11.4% upside, not including the 3.5% dividend yield.

I’d agree with analysts assessments here. When we look at iA Financial relative to peers like Manulife, Sun Life (SLF:CA), and Great-West Lifeco (GWO:CA), the company trades at the lowest book value multiple of the group at 1.3x P/BV and the lowest P/E ratio. While 2023 is a lower EPS growth year, the company has the highest earnings growth expected into 2024. Along with Great-West Lifeco, it’s also one of the only ones that’s actually increasing it’s ROE this year. Given these factors, I believe the valuation doesn’t capture the EPS growth or ROE improvement that the company should be rewarded for.

Ultimately, iA Financial remains my top pick in the Canadian insurance space. I like it’s geographic and strategic positioning and I think the latest quarter highlighted much of my expectations I set out in my outlook back in January. With management executing and delivering results above their own target, I think the company is poised for a re-rating in valuation. Given that’s only a quarter of the size of the next largest insurer in Canada, I think iA Financial is relatively underfollowed and once we give the company time to show ROE in excess of 15% for the next few quarters, I wouldn’t be surprised to see it’s the stock trade more in line with its peers. For these reasons, I’m long iA Financial and maintain my ‘buy’ rating on the stock.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.