After 13 years, Genworth Financial Inc. (NYSE: GNW), an unloved small-cap mortgage, life and long-term care insurer, began returning capital to shareholders. The return comes in the form of share buybacks to the tune of $350 million and is just one manifestation of the solid progress that Genworth has made over the past several years in securing the future of its shareholders. Going forward, Genworth owners are now well positioned to become the primary cash flow beneficiary of the business, a heartening outcome given the tumultuous road of yesteryear.
Over time, favorable progress across the business should continue for Genworth. The company’s stake in Enact Holdings Inc. (NASDAQ: ACT) will provide sufficient liquidity to fund Genworth’s cash needs as well as its growth initiatives. Then there are the company’s deferred tax assets that will provide additional and substantial cash flow in the form of intercompany cash tax payments. These payments exceed Genworth’s maintenance and growth needs and will likely be used to advance the company’s priority of returning capital to shareholders. Last but not least is Genworth’s SLD activity and progress in re-evaluating policies. The company now expects to break even within the next 5 years, well ahead of the peak loss years.
Genworth will continue to face its share of uncertainty, however. For example, the impending recession could put pressure on Enact, leading to lower capital returns for Genworth. Another possible risk is that Genworth does not generate enough taxable income in future years, rendering its CDIs unusable. Genworth could also struggle to receive future reassessment approvals from regulators, stifling the company’s progress in bringing its SLD business to breakeven.
Despite the risks, Genworth is currently on very solid foundations and should remain so for the foreseeable future. Therefore, Genworth is a buy with an increase Price Goal of $5.20/sh.
Optimal capital structure
Genworth is approaching its target debt level of $1 trillion or less. In the first quarter, the company repaid $82 million of notes due in 24, reducing Genworth Holding Company’s (“HoldCo”) debt to $1,100 million. The plan is to redeem the remaining $200 million of ’24 tickets by the end of Q3’22. At the time of repayment, HoldCo will have $900 million in debt outstanding, with the nearest installment not due until 1934:
Going forward, servicing the debt is expected to cost Genworth about $40 million annually. This is, however, assuming that LIBOR remains stable. The 1966 tickets have a floating rate, which means that when the rates go up, the cost of the tickets goes up as well. In other words, the cost of servicing debt of about $40 million a year could be $50 million by this time next year.
That said, Genworth is comfortably positioned to service debt despite rising rates, as the regular dividend set by Enact will cover more than annual interest payments.
Genworth’s approximately 81.6% controlling ownership in Enact is a cash cow. Last year, the mortgage insurer generated net income of $549 million for Genworth on $1,118 million in revenue, a margin of 49%. This year, Wall Street analysts estimate that Enact will bring in $567 million, or $3.48/sh. Based on Enact’s 40-50% target payout ratio, Genworth’s stock position is poised to reap between $185 million and $231 million in 22 of Enact’s regular and special dividends.
In April, Enact began paying dividends when its board of directors initiated a regular quarterly dividend of 14¢. This regular dividend earns Genworth $18.6 million per quarter, or $74.4 million per year, and is more than enough to cover Genworth’s annual debt servicing costs (~$40 million per year). ). Enact management has indicated that the remaining payout will come towards the end of the year and likely in the form of a special dividend.
It is possible that the recession will reduce Enact’s ability to pay a special dividend in the second half of this year. Like Genworth, Enact is highly regulated and in certain circumstances the company must receive regulatory approval before paying extraordinary dividends. In April, new home sales fell 17% year-over-year, much weaker than expected. A declining housing market is bad news for Enact, given that the company relies, in part, on taking out new mortgage insurance policies. That said, a cooling market will also lead to greater persistence, which is good for Enact. Moreover, the US labor market remains solid with an unemployment rate of 3.6% in April. Needless to say, opposing forces are at work. In any case, the regular ordinary dividend will remain and should virtually eliminate any short-term liquidity problems.
Deferred tax assets
Then there are Genworth’s DTAs. The company has a regulator-approved tax sharing arrangement under which HoldCo receives cash from its operating subsidiaries to pay Genworth’s tax liabilities. But due to Genworth’s past accounting operating losses, HoldCo can keep the cash and reuse it for other purposes. Through this tax sharing arrangement, HoldCo received cash tax payments of $127 million, $283 million, and $370 million in ’19, ’20, and ’21, respectively. Management guided between $200 million and $250 million in cash taxes to be paid to HoldCo in 22, but did not provide guidance beyond year-end.
That said, it is reasonable to believe that Genworth will receive cash tax payments in 23 and possibly 24. At the end of Q4’21, Genworth had approximately $500 million in DTA. Because the company expects to use at most $250 million of DTA this year, that would leave about $250 million in 23. Beyond that, about an additional $200 million of DTA could become available depending on the situation. outcome of the AXA litigation against Santander. Keep in mind, however, that Genworth must have taxable income to use its DTAs.
Cash tax proceeds will likely be used to fund Genworth’s plan to return capital to shareholders. In addition to authorizing a $350 million stock buyback, the board is considering a dividend starting in ’23. The buyout plan is already well advanced with $15 million used in early May, and the remaining clearance should be mined for the remainder of ’22, and possibly into ’23.
Multi-year tariff action plan (“MYRAP”)
Mention should also be made of the progress made under MYRAP. Genworth continues to make tremendous progress in its efforts to break even the company’s SLD business. MYRAP’s goal is to increase premiums for existing policies and/or reduce benefits to ensure the company has sufficient assets to cover future LTC obligations. The break-even point is $28.7 billion on a net present value basis, of which Genworth hit $20.4 billion.
Genworth’s projects claiming its old SLD fonts will peak in ~’31. Management currently expects to break even within the next 5 years, or ’27. The 5-year projection seems conservative, however, given that Genworth made around $800 million on a NPV basis in Q1’22 alone ($20.4 billion in Q1 – $19.6 billion in Q4 ). If management can maintain a similar pace, then the shortfall will be made up in less than 3 years! Additionally, Genworth will benefit from rising rates in its investment portfolio, which will also help the company achieve its long-term objective. Nevertheless, until Genworth breaks even, the LTC business will continue to be held at zero value.
Regulators may slow or stop approving Genworth’s reassessment requests. There are already several recalcitrant states that continue to deny Genworth’s claims. If this continues, or if more states stop endorsing the new rating, Genworth is unlikely to break even. This is unlikely, however, as regulators understand that they will be liable if SLD activity fails. Accordingly, it is expected that the majority of regulators will continue to approve rate increases supported by Genworth’s actuarial calculations.
By applying an evaluation by sum of the parts, Genworth is currently worth $5.20/sh, up from the previously estimated $4.35/sh. The change in valuation is primarily attributable to the increase in market value of Enact and the expectation that Genworth will receive additional cash taxes in ’23. The SOTP includes:
- Enact capital position = $3,189.1 million (132.9 million shares at $24/sh)
- Business Life = $0
- Runoff = $0
- DTA = $376 million (NPV = rate (0.15), $186 million remaining in ’22, $250 million in ’23)
- Net debt = $885M ($1,100M – $215M)
- SOTP = ~$5.20/s (517.4 months of average diluted N/A in Q1)
The SOTP implies that Genworth is currently undervalued by approximately 28%. Going forward, SOTP is expected to rise in the second half of the year as Genworth completes redemption of its ’24 notes and reduces the number of shares through its repurchase plan. This, of course, assumes that Enact continues to trade in line with its current valuation. Therefore, the upside should increase from here if Genworth stays at $4/sh.
Overall, Genworth creates real and tangible value for its shareholders. Inevitably, this will result in a rise in the stock price. Therefore, Genworth is a buy.