Sometimes when you analyze companies you start to find good to great companies all in a particular industry that are cheaply priced. You have to ask yourself why a particular industry as a whole is underperforming as was the case with home builders since 2007. Sometimes an industry underperforms for valid reasons and sometimes the reasons are not valid enough to drag down great companies.
In 2007, the home building market went south and for good reason. The mortgage debacle and great recession all acted to bring down an industry (several industries) and even the US to its proverbial knees. Now the reason behind the rapid decline in the fortunes of home builders was justified. No one was buying and mortgages were all but impossible to get as banks closed the mortgage lending spigot. The mortgage mess and resulting home market crash were products of poor lending standards.
Sometimes industries like the life insurance industry get crushed for short-term reasons. Right now the headwinds on the life insurance segment are coming from the low interest rate environment which impedes a life insurance company's earnings on its float. Most life insurance companies collect fees for life insurance for years before they ever have to pay a claim. They use these huge sums of cash called the float to invest before claims are paid and usually they choose ultra-safe investments for the float. As most people are aware safe investments like T-bills and other government backed securities are paying historically low rate of return because the Federal Reserve has kept interest rates artificially low for the past several years. This hurts an insurance company's earnings and squeezes the return on the float.
The life insurance industry sales were somewhat subdued in 2012 and the number of new policies sold, as a whole, has been fairly flat for the past five years. The industry as a whole has seen stagnant, but steady since 2009. The life insurance industry should see increasing sales as the economy improves and the unemployment rate drops. As 2013 progresses the life insurance industry will continue to face limited investment income due to low interest rates and a flat yield curve. One bright point is that variable annuity sales have been setting records sales numbers at many life insurance companies.
Largest Life Insurers, by Individual Net Life Insurance Premiums, 2011 (thousands)
Northwestern Mutual $11,449,223
MetLife, Inc. (MET) 10,543,808
New York Life 7,960,177
Swiss Re America (SSREF.OB)6,320,565
Prudential Financial (PRU) 4,195,957
Lincoln Financial (LNC) 4,131,369
Massachusetts Mutual 4,069,532
State Farm 3,945,058
AFLAC (AFL) 3,585,564
AXA Financial (AXA) 3,083,974
Protective Life (PL) 2,699,098
Berkshire Hathaway (BRK.B) 2,397,813
American International Group (AIG) 2,392,441
Manulife Financial (MFC) 2,135,712
RGA Group (RGA) 1,742,265
Pacific Life 1,633,939
Hartford Life, Inc. (HIG) 1,603,635
Thrivent Financial For Lutherans 1,526,933
Allstate (ALL) 1,506,942
Principal Financial (PFG) 1,339,044
Torchmark (TMK) 1,215,993
Source: ACLI tabulations of National Association of Insurance Commissioners (NAIC) data.
The reason I'm bullish on life insurance companies are the great values found at many companies. Many life insurers have very low relative P/E ratios, very decent dividend yields, steadily growing earnings, and many life insurers have fantastic book/price valuations. In addition, many life insurers are strengthening their balance sheets and capital positions while also reducing debt. So you have an undervalued industry that is ripe to strengthen in the future and the main way to unlock the value in these companies is with an increasing interest rate environment. Given that interest rates are being kept artificially low by the Federal Reserve you have a situation that can't last and interest rates will start to rise. My expectation is that interest rates will start to rise in the second half of 2013.
The key is to identify industries like these while they are down and choose the most promising companies while valuations are low. Now is the time to purchase ownership in this industry. The industry from a macro level is looking undervalued. What really matters through is each company at the micro level and which companies in the industry will outperform over time as the industry rebounds.
And The Winners Are
The best insurance companies for investment consideration are:
- Aegon- (AEG)
- Aflac- (AFL)
- American International Group- (AIG)
- Lincoln National- (LNC)
- Manulife- (MFC)
- Prudential- (PRU)
Aegon is a large diversified life insurer located in the Netherlands with a market cap of $12.5 billion. About 90% of their revenue comes from their US and Netherlands operations. Aegon has a P/E ratio of just 8.4% and a dividend of 4%. The company is selling at about 30% of its current book value. It's rare to see a growing company selling for such a low price/book valuation. I see Aegon climbing in value this year to a more reasonable book valuation. Aegon needs a European turnaround and an increase in interest rates to start climbing higher.
Aflac had a solid year in 2012 and is preparing to move higher. Aflac has started a new investment program that is allowing to safely earn about 70 basis points more interest on its float. Earnings are increasing at around 12% per year. Aflac is expected to continue to grow due to an aging Japanese population and a growing presence in the US.
The numbers look good on Aflac. Aflac sports a P/E of 9 and generates a 3% dividend yield. Aflac is also selling at a 45% discount to its fair market value. I calculated it value using a discounted cash flow analysis using a 12% future growth rate for the next 5 years and current earnings of $5.80/share.
AIG is moving in the right direction by shedding assets to lower its debt and by the government selling off the last of its interest in AIG. AIG posted a $6.5 billion profit for 2012 vs. a $1.5 billion profit in 2011. A reinstated dividend appears to be in the cards for 2013 or 2014. AIG's book value is $71/share vs. its current price of $30/share. AIG is selling at about a 37% discount to its fair market value. The biggest drawback to AIG is its $73 billion debt level.
I know many people still have their doubts about AIG. I think the worst is behind the company. They have faced their worst secrets and have rebounded. The underlying business that AIG still owns is a healthy and robust business. The skeletons are all out of the closet and AIG is now poised to grow.
Lincoln National is growing earnings at about 7.5% per year and it has a 2% dividend. Lincoln National's P/E ratio is a low 5.8% and it sells at a 49% discount to its fair market value. Lincoln National has risen about 20% from when I recommended the company in November 2012. The company is still selling at a 50% discount to book value and I predict that the company has room to still dramatically increase in price. My prediction is that Lincoln National will double in value by 2014.
Manulife is Canada's largest life insurance company and it appears to be doing very well. Manulife is making a major push to into Asia and business from that region is growing at a much faster rate than in Canada or the US. Manulife is at par with its book value and its debt matches its market capitalization. The company has a 4.8% yield and earnings look to double in the next 2-3 years. With a P/E ratio of 9.5% Manulife looks to have a bright few years ahead of it.
Prudential has a low 7.6% P/E ratio and a rising 3.3% dividend yield. As with most life insurers Prudential is selling for just slightly above 50% of its book value. I expect earnings to grow at a modest but steady 9% over the next 5 years. Prudential is growing its business through both internal growth and through smart acquisitions.
One risk with Prudential is that it has been notified by the government that it may be designated as a systematically important non-bank financial institution (SIFI). This would mean more oversight by the US government. This could weigh on Prudential's performance, but I still believe that the company will produce solid returns and is cheaply priced.
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