Rising rates make Power Corp. a smart bet

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The crown jewels of the Power Corp. of Canada empire are beginning to regain some of their former lustre.

As a holding company primarily exposed to Canadian insurance, Power Corp.'s fortunes are closely aligned with interest rates. When rates rise, so should the company's share price.

Investors anticipating the beginning of the end to a recession-induced era of stimulative rate policy should get in now, said Barry Schwartz, portfolio manager at Baskin Financial Services, which recently invested in Power Corp.

"You don't want to be jumping into it when rates start moving up. You want to get in when the bottom is near," he said. "And I think we're at the bottom of the interest rate cycle."

Even if rates don't co-operate, the stock has some inherent downside protection through exposure to equity markets, Mr. Schwartz said. And waiting to see if that bet pays off will earn Power Corp. shareholders a 3.8-per-cent dividend yield in the meantime.

For investors who stuck with Power Corp., it's been a long, slow climb back from the depths of the financial crisis, which brought a sudden end to the stock's stature as a staple of the Canadian investment portfolio.

"You could have bought it and forgotten it," Mr. Schwartz said. "Every year you got a nice dividend increase and stock price appreciation. Maybe we're going to get back to those days again."

Power Corp. is a holding company controlled by the Desmarais family, which, through a second holding company, Power Financial, owns controlling stakes in insurance company Great-West Lifeco Inc., and mutual fund giant IGM Financial Inc., which operates Investors Group and Mackenzie funds.

While Power Corp. has many other holdings around the world, the lifeco business contributed more than 70 per cent of its operating earnings last year. The heavy exposure explains why the stock fell so hard through the crisis.

Lifecos not only bore the initial shock of the financial crisis through credit-related woes and market losses, but they also had to contend with an extended period of rock-bottom interest rates. Insurers derive part of their profit by reinvesting premiums received from policy holders, largely in bonds.

When yields are low, profit suffers. So do Power Corp.'s shareholders. The stock lost almost two-thirds of its value before bottoming out in March, 2009. By then the company had frozen further hikes to its dividend, and it hasn't budged since. Its share price is still 27 per cent off its peak of July, 2007.

But last year was a good one for Power Corp.'s biggest holdings. IGM profited from the booming trade in equities. And Great-West Life was a beneficiary of rising long-term interest rates brought about by slowing U.S. Federal Reserve stimulus.

Power Corp.'s shares rose by 26 per cent in 2013. Since then, however, the stock has dipped as rates have eased back on renewed economic fears.

For investors who feel that the impetus for rising rates remains, now is the time to buy into the lifeco sector, Mr. Schwartz said.

So why not invest in insurance stocks directly rather than through a conglomerate such as Power Corp.?

One key reason is Power Corp. trades at a 21-per-cent discount to the total net value of the company's underlying assets. That discount is wider than its historical average of about 18 per cent, according to RBC Dominion Securities, which rates the stock the equivalent of a "buy," as do seven out of 10 analysts at an average price target of $34.79.

Mr. Schwartz said he anticipates seeing that gap narrow, and he expects to finally see Power Corp. soon implement its first dividend increase in six years. "Then you'll see the stock back to a more appropriate level," he said.

There are other benefits to owning Power Corp. over its component stocks. For one, geographical diversification through the company's international assets. One of its biggest interests beyond North American life insurance is a large stake in Pargesa Holding SA, a European investment company that owns stakes in multinationals such as Lafarge, Total and Pernod Ricard.

And there could also be greater security in its dividend, said Paul Harris, portfolio manager at Avenue Investment Management, which owns shares of Power Corp.

Mr. Harris sees the stock as underpriced. "If you look at it from a valuation perspective, these aren't expensive securities," Mr. Harris said. "You're not paying a lot to own these stocks and you're getting a very nice dividend yield."