Trupanion: The Anti-Pone Challenge Winner

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About: Trupanion, Inc. (TRUP)
by: The CrickAnt
Summary

On March, 7, Eli Hoffman launched a new contest, "Finding A Pone Stock" offering a $150 bounty for the five best articles.

As I am a bounty hunter, I searched an insurance company which could fit with Eli's criteria.

I had immediately a winner in mind: Trupanion.

Problem, it is rather an "Anti-Pone Contest Winner" than an eligible "Pone Stock".

Dang it!

On March, 7, Eli Hoffman wrote the following:

I'm doing an experiment. I'm calling it the Pone challenge. A user named pone left the following comment on my Q4 board letter:

Quote: As a long-time investor who has not subscribed yet, I want to share feedback on what would make me spend money.

I have concluded - after hundreds of stock investments - that the main source of wealth generation is by finding companies that a) have a sustainable competitive advantage; b) positive free cash flow; and c) the ability to grow rapidly for at least a decade. This is similar in philosophy to what drives Warren Buffet's investments.

After reading thousands of articles on Seeking Alpha, I have sadly concluded that almost no one who writes articles here seems to understand these points. 99.9% of the articles seem to be focused on how much money you can make in the next 12 months. All of these articles seem to be arguing for 30% up or 30% down, and there is almost no investment in understanding the basis for competitive advantage or in predicting high compound growth rates that can grow for a decade or more.

As a result, I would need to read hundreds of articles here to get even one good investment idea, and that seems to be a poor use of time. If you had a way to identify the higher quality articles that focus on important metrics for long term return on investment, that would have a lot of value. It is just as important to help me avoid reading the noise as it is to identify the good articles.

I am intrigued and would like to see articles that take his approach.

So I'm offering a $150 bounty on top of all other article payments for the first five authors that submit an outstanding article based on the pone approach.

Notes:

1. I'm not interested in stocks that are common knowledge, like FB which probably satisfies all 3 criteria.

2. It's all about the execution: Your article needs to convince me that you've identified a pone stock.

3. I'm the judge. No appeals. We'll still publish the article, assuming it meets publication standards, obviously.

4. In order to get your submission reviewed by me, do the following: (i) Add an editor note when you submit the article "Attention Eli Hoffmann." (ii) Email me to tell me you have submitted a pone candidate (eli@seekingalpha.com).

5. You may experience delays and/or obstinacy :-)

If you find or know of articles that already meet this criteria, please send them to me.

Should be fun.

By reading Eli’s announcement, I told to myself "too complicated," "too many highly skilled authors," "you’re focused on the insurance sector" to conclude “Give up Crick’.". That’s why I decided to create "The Anti-Pone Challenge." Finding one stock I follow with the following criteria:

a) Having a sustainable competitive advantage.

b) Generating a positive free cash flow.

c) Having the ability to grow rapidly for at least a decade.

d) In spite of all these unique and promising strengths, being not eligible to Eli's contest.

Regarding the above criteria, I had immediately a winner in mind: Trupanion.

A Pet Insurance Leader With A Double-Digit Growth Over The Years

Trupanion (TRUP) is an insurance carrier providing pet insurance coverage to pet owners. Founded in 2000 by Darryl Rawlings, the actual Trupanion’s CEO, Trupanion is the only pet insurance company which is publicly listed. Darryl Rawlings decided to launch his firm because he has seen the potential of being one of the first movers in a fast-growing industry.

In fact, with only 1% of the total pets insured in the U.S., the pet insurance segment is a massive underpenetrated market.

Source: Investor Presentation

In “Old Europe,” pet insurance products are much more present in some countries. In Sweden, 40% of the pets are insured. In the U.K., 25% of the pets are covered by an insurance product.

As the market remains underpenetrated, the firm has succeeded to grow revenues by more than 20% per year over the years.

Source: Q4 2018 Earnings Release

Thanks to its rapid growth, Trupanion became the second largest player in the U.S., with a market share of close to 30%.

Source: IBISWorld Report

In addition to rapid growth in the total number of pets insured, the loyalty of the company’s existing clients has also benefited Trupanion substantially. From 2010 to 2018, the average retention was above 98%. In 2018, while 98,132 new pets were enrolled, the retention rate was maintained at 98.6%.

Source: Q4 2018 Earnings Release

In 2018, the total revenues rose by 25% to $304 million, proving that Trupanion was able to continue growing apace.

Source: Q4 2018 Earnings Release

For the next decade, the industry revenue is anticipated to rise at an annualized rate of 13.4% during the first five years. During the second half of the decade, the industry revenue should grow at an annualized rate of 7.5% to reach $1.5 billion.

A Free Cash Flow Machine

It is one of the most often arguments used by Trupanion’s management. After some years of negative free cash flows, the company was able to generate positive cash flows, after having made the efforts to reduce the costs and reach the necessary critical size.

From 2012 to 2017, the free cash flow improved significantly by $10.1 million to $6.5 million.

Source: Investor Presentation

In 2018, excluding the cash outflow of $52.5 million related to the purchase of the company's headquarters building, the free cash flow was $8.3 million, or 35% higher than in 2017. Pretty impressive, no?

When You Can’t Compete With The Rules, Change Them

I was pretty sure not to be one of Eli’s top choices. So, I decided to create my own contest, with my own rules. Trupanion did the same.

It is true that Trupanion is the second largest pet insurer in the U.S. and the leader in Canada. I can’t deny the facts. The revenues grow by more than 20% per year and will certainly continue increasing by at least 10% every year, as the pet insurance demand will remain strong.

The problem is, free cash flow means nothing for an insurance company. I would rather say that concepts like “working capital” and “free cash flow” are no longer applicable for financial institutions, insurance companies included.

And the second problem is, Trupanion is an insurance company. I know, Trupanion’s management does not share the same opinion about the company. Trupanion is certainly a disruptive and fast-growing firm, but one rule applies to non-life insurance companies like Trupanion.

To make money, your costs to acquire and administrate the policies and the claim payments should be lower than the premiums that you receive from your policyholders. I know it’s an old-fashioned way to assess the profitability of a company, but it is an industry standard.

Oh, by the way, we call this metric “combined ratio,” which is the sum of the loss ratio (claims incurred divided by the earned premiums) and the expense ratio (the operating expenses divided by the earned premiums). A combined ratio below 100% means that an insurance company is profitable. Above 100%, it is a loss-making one.

So what about Trupanion and its improving free cash flows?

Mhh…

Erf…

How to say that with some kind words?

From an old-fashioned actuarial point of view, Trupanion does not make any profit. It is a loss-making company.

From 2014 to 2018, the combined ratio improved but remained above 100% unfortunately.

Source: Author’s calculation (based on Trupanion’s reports)

And as mentioned above, a combined ratio above 100% means that the portfolio is not profitable. Period.

What About Eli’s Contest?

As I said, I’m pretty sure not to find a company which fits with Eli’s criteria and to sell it to him properly. Especially with Trupanion, a loss-making leader traded at about seven times its book value (!).

Or let me think…

Maybe… Progressive Corporation (PGR), the third largest motor insurer, combining growth and strong operating performance?

Yeah maybe. But, in another article, then. Now, I have to leave; my bounty awaits me.

(Told ya, I'm a bounty hunter.)

Disclosure: I am/we are long PGR. 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.