In the midst of economic uncertainty, the market has reason to be hesitant about backing insurers. But, in my view, financials are heavily discounted, specifically because of the prospects of a "double dip". While the jobs numbers have been indisputably disappointing, the economy is still heading in the right direction. Over the last 12 months, while the S&P was roughly flat to positive, MetLife (MET) lost 30% in value while Lincoln National (LNC) fell 27.2% and Aflac (AFL) fell 8.3%. Going forward, insurer investors should seek Aflac again for more safety and Lincoln and MetLife for more upside.
Aflac currently trades at a respective 8.5x past earnings, but companies are ultimately based on future performance. The insurer trades at 6.2x forward earnings and a PEG ratio of 0.76, which indicates that future growth has not been fully factored into the stock price. Moreover, the company is mostly diversified outside of domestic markets, with 80% of its business coming from Japan. Greater emerging market exposure further represents a meaningful way to unlock shareholder value.
If Aflac grows EPS by 11.1% off of 2013 EPS of $6.88, it will realize 2016 EPS of nearly $9.50. At a 12x multiple, the future value of the stock is $133. Now what is the margin of safety under the assumption that the company will triple in value? Discounting backwards by 12% yields a price target of $75.50, so there is approximately a 75% margin of safety. This bullish case also falls within the context of strong free cash flow growth over the past half decade.
A more risky, but still attractive, investment is Lincoln. The company trades at just 4.7x forward earnings and is half of book value, but the stock is 161% more volatile than the broader market. Moreover, ROA and ROE are very low, and analysts rate the stock only around a "buy" according to FINVIZ.com.
Despite the precipitous decline in value, Lincoln has consistently beaten expectations over the past 5 quarters by an average of 8.6%. Based on the Graham fair value formula of sqrt (22.5*TTM EPS* MRQ BVPS), the stock should be worth $21.23 - thus, there appears to be a significant discount to intrinsic value.
MetLife is doing just exactly what its peers should be doing: it is increasing emerging market exposure. Management aims to grow its business in these high-growth markets by around 20% each year, and I believe that the business has the brand name capable of resonating abroad. Despite better-than-expected performance consistently throughout the last five quarters, the stock has tumbled in value. Analysts currently expect mid single-digit growth over the next two years, which sets the bar low for high risk-adjusted appreciation.
MetLife has a PEG ratio of only 0.54 and trades at 5.7x past earnings. It is also valued at nearly half of book value and is rated near a "strong buy" on The Street, according to data from FINVIZ.com. If the firm realizes $5.60 EPS by 2013, and then grows 10.5% annually over the near-term, the future value of the stock will be $83.07 at a low 9x multiple. Yes, interest rates are low, but the market simply is factoring too high of a discount rate based on earnings appreciation. Discounting backwards by 12% yields a price target of $51.58 for 70% upside. The market seems to be factoring in an absurdly high discount rate of 23%. Investors are thus encouraged to aggressively buy shares before we hit a full recovery inflection point, and most of the discount is already bridged.
Disclaimer: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.