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Summary

  • National Western Life Insurance is a provider of life insurance products with a pristine balance sheet.
  • NWLI’s stock is undervalued relative to the value of its assets and earnings potential.
  • NWLI is heavily controlled by its founder and other insiders.

In the late 1960s, Stanford University psychologist, Walter Mischel, began a series of studies on delayed gratification. In these studies, which have since been analyzed and written about countless times, a child was offered a choice between an immediate reward (a marshmallow) or double the reward (two marshmallows) in fifteen minutes. The subjects of the studies were then followed into their adulthood. The children who had chosen to wait fifteen minutes for the larger payoff tended to become more successful in life. Those children did better in areas such as SAT scores, fitness, and educational attainment. Value investors, like the children who were able to wait the fifteen minutes, are able to delay immediate gratification for future rewards. However, unlike the children, value investors often do not know how long they have to wait to finally get their rewards.

When I buy stocks (exceptions include special situations), I look to buy either company assets or earnings potential at a discount. In the past I have written about companies like Microsoft (NASDAQ:MSFT) that are good examples of offering their earnings potential at a discount. Other companies such as Deswell (NASDAQ:DSWL) and Gencor (NASDAQ:GENC) are excellent examples of companies whose assets are selling at a discount. With current equity valuations, it is rare to find a company that is selling at a discount with regards to both its earnings potential and assets. Despite about a 50% price increase in the past year, National Western Life Insurance Company (NASDAQ:NWLI) is a rare gem still selling at a large discount to the value of its assets and its earnings potential.

Overview

NWLI provides life insurance products in 49 US states and the District of Columbia. It also sells insurance products to mainly wealthy individuals internationally. The company was chartered in the State of Colorado in 1956 and is based in Austin, TX. Its stock is divided into two classes. The current Chairman of the Board and CEO, Robert Moody, who acquired the company in 1963 owns 99% of class B stock. He and various family members are firmly in control of this company. Holders of class A shares elect one third of the Board of Directors. Class B holders elect the remaining members. Insiders, as a group, control 99.8% of class B shares and 34.8% of class A shares. Aside from voting rights, class B shareholders have no other rights over class A holders. In fact, class B holders are entitled to only half the dividends of class A holders. NWLI distributes very small dividends. The Board of Directors is comprised of numerous Moody family members. The CEO's son, Ross Moody, is the President and Chief Operating Officer of the company.

Mr. Robert Moody has been an outstanding steward of NWLI. In the past fifty years he has grown the company's assets from less than $20 million to nearly $11 billion. To say that the company adheres to conservative accounting principles for an insurance company is an understatement. From the company's 2013 annual report:

"In their most recent analysis of the company, Standard & Poor's even went so far as to indicate that National Western's capital is 'redundant at the AAA level as per our risk-based insurance capital model'."

The company has zero debt and has been generating solid earnings for years. State insurance laws restrict dividend amounts without prior approval. For 2013 the maximum dividend payment which NWLI was allowed to pay to shareholders without prior approval from the Colorado Division of Insurance was $100.5 million. This is approximately $27 per share. In 2013 NWLI distributed only $0.36 of dividends, a tiny fraction of the allowed amount. NWLI's conservative accounting principles have enabled it to achieve one of the most pristine balance sheets in the industry.

Earnings Power

Below is a table of the company's revenues and earnings (value in thousands except per share amounts) for the past decade (source: NWLI 2013 annual report).

Year

Premiums and Contract Revenues

Total Revenues

Net Earnings

Diluted EPS

2013

167,466

860,267

96,247

27.19

2012

167,944

664,662

92,558

26.19

2011

150,211

572,747

55,627

15.73

2010

143,757

575,992

72,897

20.61

2009

162,693

568,406

45,484

12.87

2008

151,177

411,079

33,642

9.48

2007

139,191

474,507

85,371

23.95

2006

122,126

521,859

76,343

21.46

2005

111,367

441,043

77,267

21.83

2004

103,538

434,146

122,169

34.87

2003

94,880

399,268

55,782

16.10

2003-2013 CAGR

5.8%

8.0%

5.6%

5.4%

The company has delivered positive earnings consistently even in the dark years of the recession. At the current stock price of about $235, NWLI's PE ratio is less than 9. Besides generating consistent earnings, a great company must also translate those earnings into shareholder wealth. As I will show below, NWLI has turned its earnings into shareholder equity. Investors may assume that a company with an earnings yield of over 11%, during these times when investors increasingly undertake greater risks for yield, must be trading at a significant premium to the value of its assets. NWLI is actually trading at a significant discount to the value of its assets.

Assets at a Discount

The table below depicts the company's shareholder equity and share count over the past decade.

Year

Shareholder equity (NASDAQ:BV)

BV per share

Class A shares Outstanding

Class B shares Outstanding

Total shares Outstanding

2013

1,447,948

398.36

3,434,765

200,000

3,634,765

2012

1,391,680

382.88

3,434,763

200,000

3,634,763

2011

1,276,785

351.27

3,434,766

200,000

3,634,766

2010

1,218,791

335.83

3,429,241

200,000

3,629,241

2009

1,114,053

307.24

3,425,966

200,000

3,625,966

2008

986,213

271.99

3,425,966

200,000

3,625,966

2007

1,011,685

279.29

3,422,324

200,000

3,622,324

2006

932,984

257.67

3,420,324

200,000

3,620,324

2005

874,008

241.89

3,413,199

200,000

3,613,199

2004

808,672

225.62

3,384,215

200,000

3,584,215

2003

679,858

191.69

3,346,685

200,000

3,546,685

2003-2013 CAGR

7.9%

7.6%

0.3%

0.0%

0.2%

In addition to consistency of earnings, NWLI has managed to grow its book value by over 7% in the past decade. They have achieved these results in a challenging economic environment without taking on debt or significantly diluting shareholders.

In the past nine years the company has earned $757,605. During the same period shareholder equity has increased by $768,090. This means that NWLI has turned its earnings into shareholder wealth. But an astute investor must ensure that the numbers also hold on a per share basis since many companies destroy shareholder value through dilution. On a per share basis, the company has earned $214.18 over the past nine years while growing BV per share by a comparable amount of $206.67. Hence dilution has played little role.

Fair Value

What is the fair value of NWLI? The company's book value is about $398 and EPS is $27.19. At the current stock price, NWLI is trading at less than 60% of its book value and PE of less than 9. For a company of this caliber a 20% premium to book value is not unreasonable. In fact I would gladly hold these shares if the stock price rose to that level. A 20% premium to book value would be a stock price of about $478, and since the stock price is around $240 now, NWLI has a 100% price appreciation potential.

When will investors get their two marshmallows? Who knows, but NWLI continues to increase its shareholder equity as we wait for Mr. Market to catch up. Mispricing is more prevalent when companies' stock is tightly held. The Moodys have little interest in managing the stock price and are correctly focused on running the business. Management's long-term focus may not suit many mutual fund managers, hedge funds, and institutional investors who often seek dividend yields and short-term gains. This creates a major opportunity for patient individual investors who understand the true value of this company.

In the past, I have argued that some companies hoard cash unnecessarily and destroy shareholder value. I believe NWLI is more like Berkshire Hathaway (NYSE:BRK.A). I am happy to let both these companies retain their earnings since they have done phenomenally at utilizing those earnings historically. As an added benefit shareholders of these companies can defer their tax bill into the future.

Risks

NWLI is not a micro-cap but given its high insider ownership and low float, it trades like one. Average trading volume is less than 5000 shares or about $1 million daily. Institutional investors cannot accumulate a meaningful position in the company despite NWLI's over $800 million market cap. It takes patience and use of limit orders for individual investors to acquire this stock. In addition, investors who have a limited time frame may be disappointed in their short term returns since management cares little if the stock remains undervalued. There is no catalyst for change in control of this company or a sale. Hence NWLI may remain undervalued for a prolonged period. As a long-term investor, I am content with this situation since I am confident that the Moodys will continue growing shareholder equity at a reasonable rate as they have done for the past fifty years. NWLI investors may not get their marshmallows now, but with enough patience the future may promise an even better treat: S'Mores!

Disclosure: I am long NWLI, MSFT, BRK.A, GENC, DSWL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: National Western Life Insurance: Life Is Good