MetLife, Lincoln Still Have At Least 30% Upside

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Includes: LNC, MET
by: Takeover Analyst

Despite disappointing global economic growth, insurers have been on a surge of late. Since I first presented my bullish case on MetLife (NYSE:MET) here, the stock has risen by 23.5% and the Street still rates it near a "strong buy" versus a "buy" for Lincoln National (NYSE:LNC). Based on my review of the fundamentals and multiples analysis, I find substantial upside for both firms.

From a multiples perspective, MetLife and Lincoln are a bargain. They trade at a respective 7.1x and 7.6x past earnings, which is nearly half that of average peer levels. They also have substantial double-digit free cash flow yields, which (combined with their high betas) will catalyze value creation from a macro recovery.

At the third quarter earnings call, Lincoln's CEO, Dennis Glass, noted solid performance:

We produced another quarter of very strong operating results with increases in operating income, operating revenues, deposits and flows, particularly good momentum in our Group Protection and Defined Contribution businesses. Highlights in the quarter include sales increases and positive net flows in nearly every business, resulting in $5.5 billion of deposits and $2 billion of bonds net flows. A 6% increase in operating revenues and a 54% increase in income from operations. Also, we accelerated our capital management activities which, year-to-date, includes $375 million worth of shares repurchases. On a net basis, our results this quarter were affected by abnormally volatile [ph] markets and other atypical items. Randy will go into these in more detail in a moment. Low interest rates and capital market volatility continue to drive headlines for this industry. As we've shared previously, although sustained low interest rates would impact the rate of earnings growth for Lincoln over time, we do not expect low rates to materially affect the balance sheet.

The firm has done well to restructure its balance sheet with liquidity in order to reduce risk. Lincoln further has an attractive stream of cash flow from nearly all of its segments while still remaining appropriately diversified. At the same time, the Fed's announcement that it will be extending low interest rates into 2014 will constrain ROE as competitive and regulatory pressures rise. The addition of Guaranteed Minimum Withdrawal Benefit to the offerings of other insurers' variable annuity plans will further hinder growth.

Consensus estimates for Lincoln's EPS forecast that it will grow by 29% to $4.18 in FY2011, decline by 5.3% in FY2012, and then grow by 9.8% in FY2013. Assuming a multiple of 8.5x and a conservative 2012 EPS Of $3.91, the rough intrinsic value of the stock is $33.24, implying 35.3% upside.

While Lincoln has proven itself operationally, MetLife is showcasing strength through strategy. Roughly one month ago, management announced that it would stop operating its retail mortgage loan origination business. This helps to reduce the chance that the company gets deemed "systemically important," which would subjugate it too even more onerous regulations. And while management has not pushed the idea, it becomes increasingly likely that it will eventually stop operating its reverse mortgage business. Operations from this segment offer more red flags for regulators than meaningful contribution to revenues.

Moving onto the international scene, MetLife has dramatically increased scale through acquiring ALICO from AIG. Many view this as a colossus that will be too difficult to manage while adding unnecessary FX headwinds. In my view, it helps to hedge against domestic stagnation and has no impact on economic income so far, as profits are not repatriated.

Consensus estimates for MetLife's EPS forecast that it will grow by 11.8% to $4.91 in FY2011 and then by 3.3% and 10.3% in the following two years. Assuming a multiple of 10x and a conservative 2012 EPS of $4.95, the rough intrinsic value of the stock is $49.50, implying 31.3% upside.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.