Presidential Life (NASDAQ: PLFE) closed on March 6th at a price of $9.82 per share, or roughly 37% of tangible book value, which totaled $27 per share as of September 30, 2011. In my opinion, this stock is worth $23 per share, which means that Mr. Market has once again managed to completely misprice an asset. According to Capital IQ, Presidential Life has traded at an average of 85% of tangible book value over the past twelve years. From 2000 through 2008, Presidential Life traded at 97% of tangible book value. Over the past three years, however, the company's stock (like many of its peers) has traded well below long-term averages. What's the story here?
Presidential Life engages in the sale of various annuity, life insurance, and accident and health insurance products in the United States. Like many other annuity providers, Presidential Life has struggled to generate annuity product revenue in such a low interest rate environment. So why do I think this stock is worth $23 per share? Let me explain.
First of all, most of the deferred and immediate fixed-rate annuity products sold by Presidential Life only guarantee rates for one to six years. Therefore, it should not be too difficult for a competent underwriter like Presidential Life to continue making a profitable spread on its annuity products.
Second, interest rates can't stay this low forever. When interest rates begin to move higher, annuity products will be in much higher demand from the aging baby boomer population. Presidential Life and the industry in general can be viewed as a call option on higher future interest rates.
Third, Presidential Life has the best balance sheet in the business. Most insurers have significant deferred policy acquisition costs on their balance sheet. Deferred policy acquisition costs are the costs (i.e. commissions, underwriting expenses etc.) associated with acquiring a new customer over the duration of the insurance product. In my opinion, this booked asset overstates the tangible book value of many insurers. Fortunately, Presidential Life has very minimal deferred policy acquisition costs (only 5% of book value). National Western Life (NASDAQ: NWLI) has $715 million of deferred policy acquisition costs on its balance sheet and a book value of $1.227 billion (representing 56% of book value). MetLife (NYSE: MET) has $18.59 billion of deferred policy acquisition costs on its balance sheet and a book value of $59.8 billion (representing 31% of book value). The Hartford Financial Services Group (NYSE: HIG) has $8.74 billion of deferred policy acquisition costs on its balance sheet and a book value of $22.35 billion (representing 39% of book value). The bottom-line here is that the actual liquidation value of Presidential Life is much closer to its tangible book value than many of its peers in the annuity and life insurance industry. See the latest quarterly report.
Fourth, compared to many other industry players, Presidential Life is overcapitalized. The company has no debt. Its book value as of September 30, 2011 was $798.5 million, and it had total assets of $4.0 billion. Therefore, book value as a percentage of total assets was 20%. This compares to other industry players like Kansas City Life (NASDAQ: KCLI) with a book value of $711 million and total assets of $4.4 billion (representing 16.2%), American Equity Investment Life (NYSE: AEL) with a book value $1.41 billion and total assets of $30.87 billion (representing 4.6%), and MetLife with a book value of $59.8 billion and total assets of $799.63 billion (representing 7.5%). With its strong balance sheet, Presidential Life could increase its dividend or repurchase a significant percentage of its outstanding shares.
Fifth, Presidential Life is in the early stages of becoming a growth company. The leadership team is in the process of refocusing the company's investment portfolio to maximize current income. It is also expanding Presidential Life's annuity product portfolio as well as its geographical presence. Historically, the company has been a regional player. It is now making strides to create a national platform.
Sixth, on a LTM basis, the company has generated earnings before taxes of $61.2 million. As of the March 6th close, the company had a market capitalization of $290 million. This means that the company has generated a 21% return on the current market value of its equity. That's pretty compelling.
Disclosure: I personally own shares of PLFE. The accounts that I manage also own shares of PLFE.