Great-West Lifeco: The 6% Dividend Increase Is Welcome (OTCMKTS:GWLIF)

Introduction

Great-West Lifeco Inc. (TSX:GWO:CA, OTCPK:GWLIF) is one of Canada’s largest financial services companies. It has a strong focus on health insurance, life insurance, and an increasing focus on retirement and investment services. In my previous article, I wanted to focus on the recent acquisitions in the retirement services sector, and as Great-West has now published its full-year results I, figured this is a good time to follow up on the company, as its share price is up by 15% since mid-October, and since it has just announced a dividend increase.

Great-West ended the year on a strong note

Great-West wants its shareholders to focus on the “base earnings”: a non-GAAP metric which aims to remove the “white noise” from the earnings results. While the third quarter was pretty weak for Great-West, its financial result at the end of the year was pretty good. Not only did its total amount of assets increase to C$701B, the total amount of assets under management and administration increased by about 4% and almost 5%, respectively, to C$1.03T and C$2.5T.

The base earnings came in at C$892M while the net income in the final quarter of the year just exceeded C$1B. This resulted in an EPS of C$1.10 based on the net income, and just under C$0.96 per share if you would just take the base earnings into consideration. The difference between the base earnings and reported net earnings is pretty easy to explain. As mentioned above, the base earnings remove the “white noise” from the equation, and the image below shows how, for instance, the negative impact of actuarial assumption changes and the impact of an updated tax legislation are added back to the equation.

Interestingly, looking at the full-year results, the reported net income and the base earnings are exactly the same, but this is mere coincidence.

Great-West Lifeco Inc. has been paying a quarterly dividend of C$0.49 per share, but has now hiked the dividend by 6% to C$0.52. The full-year dividend of C$2.08 per share currently represents a dividend yield of approximately 5.8%. Considering the payout ratio is still just around 60%, I think Great-West will be able to hike its dividend again in the near future.

The preferred shares are interesting as well

Keep in mind the reported net income of C$3.2B also includes the C$130M in preferred dividends the company owed on its preferred shares. Most of the preferred shares it has issued have a fixed preferred dividend, but the N-shares is one of the two issues with a five year reset.

The N shares are currently paying just 1.749% per year (just under C$0.44 per preferred share per year) but will reset at the end of December 2025 to the 5 year Canadian government bond yield plus a mark-up of 130 basis points. As the current 5 year yield stands at 3.27%, this series of the preferred shares would reset at 4.57% based on today’s 5 year bond yield. That would represent an annual preferred dividend of C$1.1425 per share, and based on the current share price of C$12.65, the yield would jump to 9% if one would buy that security right now.

Does this mean the market is mispricing the N-shares? Not really. The reset date is still almost three years away so if the preferred dividend indeed resets to C$1.1425 per share from 2026 on, investors will generate an average yield of 6.9%. That’s pretty good, but it assumes that in this scenario, the 5-year Canada government bond yield doesn’t drop further as a good reset is needed to bring the total return on the longer term in line with the fixed-yield preferred shares. Right now, these N-series are offering a preferred dividend yield of less than 3.5%, so anyone who buys these securities would kinda like to see the 5-year Canada bond yield exceed 2.5% by the time the reset date comes around.

Thanks to the strong financial results of Great-West, the preferred dividends appear to be safe: during FY 2022, Great West needed about 4% of its net income to cover the preferred dividends, resulting in a very safe coverage ratio of almost 2,600%. That’s important as Great-West’s preferred shares are non-cumulative so a dividend suspension should be avoided at all costs.

And looking at the liabilities side of the balance sheet above, we see the total amount of equity is C$32.3B. About C$3.3B ranks senior to the preferred shares, but as the total amount of preferred equity that is currently outstanding is “just” C$2.72B, it basically means there is about C$26B in common equity which ranks junior to the preferred shares. So while the non-cumulative status is something to be mindful of,

Investment thesis

Great-West Lifeco ended 2022 on a strong note and I am looking forward to seeing how the asset manager and insurance company will continue to unlock the synergy benefits from its recent acquisitions. The 6% dividend increase is encouraging, and as the share price of the preferred shares recently gained back quite a bit of the ground it previously lost, the preferred shares are now no longer more attractive for the income-searching investors.

Based on the current share prices, I prefer the common shares of Great-West Lifeco Inc. due to the relatively strong (and increasing) earnings and the potential for future dividend hikes. Although Great-West Lifeco Inc. stock is trading at a premium of almost 40% to the book value, keep in mind the book value per share increases on an annual basis as Great-West retains a decent portion of its net income.

I will keep an eye on the N-series of the preferred shares, but that would be more a speculative bet on the reset at the end of 2025.

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.