Deep Value at National Western Life

| About: National Western (NWLI)
Many individual investors avoid taking positions in life insurance companies. They find the business boring and the financials complex.
This is a mistake in my view. The insurance business can provide great investment opportunities when the right companies are bought at the right times. Warren Buffett and Shelby Davis are two very notable investors who found great success investing in insurance companies.
National Western Life Insurance Company (NASDAQ:NWLI) has been in the business since 1956. The Austin, Tex.-based company is run by the Moody family with Robert L. Moody (75) holding the reins of Chairman and CEO and his son Ross R. Moody (48) acting as President and Chief Operating Officer. The senior Moody owns 34.4% of the outstanding Class A shares in the company as well as 99% of the Class B shares.
NWLI sells universal life and annuity contracts as well as traditional life insurance. Annuities made up over 80% of its revenues as disclosed in its most recent 10-K filing. About 85% of revenues are U.S.-based. The company also derives significant profits from investment income, largely in the fixed income arena.
While the Moody family retains tight control, shareholders have also been rewarded historically. During the period of 2002-07, NWLI roughly doubled its earnings from $11.84/share to $23.3/share. Book value increased by 62% over that five-year period. The share price increased from roughly $110 to $275 at its peak in 2007-08.
Taking a look over a longer period, the shares increased by roughly 8x from 1995-2007. Shareholders need to count on share price appreciation, since NWLI pays a scant dividend of only 0.2%.
The economic downturn was a major hit on NWLI, particularly in the area of life insurance. Some of its fixed income investments were also impacted. Earnings dropped to $9.48 in 2008 and $12.87 in 2009. The company notes that its annuity products remained relatively strong during this time, as customers sought out lower risk vehicles.
In 2010, NWLI saw a nice recovery. It is likely to earn $18.90 this year, roughly 81% of its peak earnings seen in 2007. However, its share price is still languishing at 62% of the peak values seen in 2007-08. The company also appears to be very cheap on a book value-basis, trading at just 51% of book. NWLI tends to trade at a discount, possibly due to the factor of family control and the fact that its shares are fairly illiquid and thinly traded. But the 51% of book discount is extreme. In 2006-07 the company traded at 85-88% of book.
NWLI is subject to risks from dramatic changes in interest rates. A key component of profitability is investment spread, or the difference between the yield on its investments and the rates it credits to policyholders on products. But NWLI has managed well through widely different conditions in the U.S. interest rate environment seen since 1956, and is likely to do so in my view on a long-term basis. The company is also subject to some regulatory risk as noted in the report from credit rating agency AM Best. The SEC could rule that annuities are securities, requiring a registered representative sales force differing from NWLI’s current sales organization.
In June 2009, Best upgraded NWLI’s credit rating to excellent, which has since been affirmed. NWLI describes this as noteworthy in its regulatory filings, “given the financial crisis backdrop that has framed the past two years and the number of companies that were negatively impacted, often significantly, in this environment.” Standard & Poor’s give NWLI a “Strong” rating but with a negative outlook. NWLI comments in its 10-K:

Standard & Poor’s maintains a “negative outlook” on the life insurance industry overall, which means that the rating of many U.S. life insurance companies may be downgraded due to the impact of negative market conditions.

47% of NWLI’s investment portfolio is in corporate bonds, 32% in mortgage backed securities, and 15% in bonds backed by public utilities. According to Best, the company has minimal exposure to sub-prime and Alt-A residential mortgage markets. NWLI carries no long term debt on its balance sheet.
My view is that NWLI is significantly undervalued at its current price, around $170/share. I would project that book value will increase at 8%/year over the next three to four years to about $450/share. As investors gain additional confidence in the economic recovery, the discount to book should narrow to a more normal 80%, a value still below the 85-88% value seen in 2007-08.
On this basis I would project a 2014-15 stock value of roughly $360/share, or more than double the current price. On an earnings basis, if earnings can increase at 12%/year, I would project EPS around $29.7 in 2014-15, corresponding to a P/E of just over 12x, which seems reasonable. If the company could return to the 15%/year increase in earnings and the 13%/year in BV seen in the 2002-07 period, these projections could be conservative.
It is also worth noting that Third Avenue Management, run by noted value investor Marty Whitman, owns over 9% of the shares.
I have recently purchased shares in NWLI for my individual accounts and accounts managed for Freedom Mountain Investment clients in the $170/share area. NWLI is a thinly traded stock, so it is advisable to make any purchases using limit and All or None orders.
Disclosure: I am long NWLI.