Wolf's Corona Discounts: Reinsurance Group Of America

Summary

• In what may well be one of the last Corona-discount articles, we take a look at the Reinsurance group of America.
• Company operations are appealing and the current valuations show a continuing undervalued picture, disconnected from the company's positive earnings.
• Because of this disconnect between assumption and current reality, RGA is a "BUY".

We may well be looking at one of the last articles entitled "Corona discounts". As we move forward, companies move back up more and more towards standard valuations. While discounts still exists across all sectors - you can view my articles on this - they're thinning, and especially what i consider class 1 companies are moving back quicker and quicker to more standard valuations.

Reinsurance Group of America (NYSE:RGA), thankfully, is not doing so just yet.

As discounts slowly disparate, we need to deploy our capital with the precision of tactical airstrikes in order to make investments that give us good potentials of appreciating due to their valuations and forward expectations. RGA, as i see it, is an underfollowed and underappreciated gem of a company. You should at the very least look at this business and decide for yourself.

In this article, the purpose I have is to present RGA, do some groundwork, and give you a point from which to move forward.

Reinsurance Group of America - What does the company do?

RGA is, as the name suggests, a business that operates in the reinsurance industry. The company is a Fortune 500 company, with about $3.3 trillion of life reinsurance in force, and company assets of about $64.5B. These two numbers alone make RGA into one of the largest life reinsurance companies in the world.

So, with that out of the way - the company is about 40 years old, and headquartered in Missouri. While the company itself is 40 years old, the General American Reinsurance was a division formed in 1973, and it was the forerunner to RGA (out of the General American Life Insurance Company, which today is called Metlife (MET))

The business of reinsurance is, on the face of it, a simple. The business of reinsurance is a way for insurers to transfer downside risk in their portfolio to a third party, thereby reducing the likelihood of a massive payout obligation from a large insurance. This allows insurers to remain solvent, as they're able through reinsurance to recover some or all of the amounts paid to claimants. RGA's customers, known as ceding companies, are also enabled to increase their underwriting capabilities through reinsurance, increasing the raw number as well as the size of risks.

There's a few types of reinsurance - facultative and reinsurance treaty, proportional and non-proportional reinsurance. RGA is a leader in facultative reinsurance coverage, which protects RGA's customers from an individual or specified risk. If more risks need covering, they are negotiated separately. The difference with the treaty is that it's for a set period as opposed to a per-risk/contract basis, and the reinsurer covers all/a portion of the ceding company's risk that may be incurred.

In proportional reinsurance, the reinsurer receives a prorated share of all policy premiums that the ceding company sells. Reinsurance company expenses or claims are then borne on a pre-negotiated percentage, as well as reimbursing for processing, acquisition and writing costs.

In non-proportional reinsurance, the reinsurance company only goes "into play" if an insurer's losses exceed the so-called retention limit, a set amount. The reinsurance company does not have a proportional share of premiums or losses, and the retention limit is calculated either on individual risk or risk category.

It goes without saying that a reinsurance company needs perhaps even better analytics, data understanding, and claims handling skills than insurance companies to reduce overall costs and risks.

So - RGA claims that solid understanding of mortality, morbidity risks, shared medical underwriting knowledge and processes developed from extensive research and experience makes their company a leader in facultative underwriting. Their specialization is large cases and substandard risks.

In terms of geographical diversification of their operations, things are looking good.

(Source: RGA Investor presentation)

While NA/LATAM accounts for over half of company operations, there's still a significant global presence here. The company has made a journey here. 20-30 years ago, we were looking at a company that exclusively dealt with mortality reinsurance in NA - today we're looking at a very different company.

(Source: RGA Investor presentation)

RGA's ratings are some of the best in the industry at what they do, and the ratings given to the company's operations and debt reflect this.

(Source: RGA Investor presentation)

The company also earns plenty of "fluff" awards which, while not as important as results, at least indicate that the company is well-known and receives impressive highlights for its work.

(Source: RGA Investor presentation)

On the peer side, the global reinsurance market is pretty much dominated by 5 players. These are Swiss Reinsurance (OTCPK:SSREF) - which are the largest at a revenue of $14,555M, followed by RGA, which are a close second at ~$13B. From then, they include Munich Re (OTCPK:MURGY), SCOR Global Life RE (no Symbol) and Hannover RE (OTCPK:HVRRF). Together, these 5 players hold about 80% of the global reinsurance market. It's a high-barrier/high-moat market, and an extremely concentrated industry.

RGA offers a full range of services in this industry and depends on its strong brand, market prominence and experience to remain in its current position. Some research and studies have shown that RGA does this well, and indeed does it better than others...

(Source: RGA Investor presentation)

Though everything such as this should of course be taken with a great deal of salt.

RGA gains business not through insurance brokers or third parties, but through its own sales and marketing team that attempts to provide service and maintain relationships. RGA's customers are aimed at primarily the largest insurance companies in the world. In 2019, the company's 5 largest clients generated about 20.6% of company gross premiums/other revenues, which is fairly concentrated. Another 29 clients generated an additional $100M or more each, which means that 34 company clients represented 44.1% of company gross premiums ad revenues.

No individual RGA client amounts for 10% or more of the company's revenues. Company operations are segmented through both a geographical basis, as well as an operational basis.

We have:

• US/LATAM Operations, containing traditional life and health reinsurance, as well as reinsurance of asset-intensive products, financial reinsurance, and other solutions - primarily U.S life insurance companies. This segment is the area where RGA operates both asset-intensive reinsurance, (such as risks with annuities and investment-oriented products with agreements structured as coinsurance, as well as guaranteed investment contracts to retirement plans) and Capital solutions. Capital solutions focus on assisting ceding companies in meeting requirements while enhancing financial strength through assuming insurance liabilities. This also involves things like, assuming real estate leases, providing asset support, and other actions in the event that certain things occur.
• Canada Operations contains traditional reinsurance and financial solutions. Financial solutions in Canada only involve underlying annuities and investment-oriented products through coinsurance agreements. The company also does some small business in Capital solutions, as mentioned above. The difference here is that Canada is a very concentrated market for RGA, with the five largest RGA clients generating about 60% of gross premiums and revenues for the segment.
• EMEA is the company's Europe, Middle East, and Africa segment, providing the above-mentioned services in the relevant geographies. Again, the segment is slightly concentrated, with the five largest clients representing ~46% of EMEA operations.
• Asia Pacific Operations. The same reinsurance and financial services are offered here as well.

(Source: Investor Presentation)

It's important to mention these segments despite their seemingly-identical operations because their operations are in fact not identical. A whole host of domestic and international laws and oversight guide RGA's work across the globe, with very specific and far-reaching consequences on a geographical basis. As an example, Financial reinsurance transactions in Asia-Pacific and EMEA regions do not qualify as reinsurance under GAAP due to their remote risk nature, and are reported under deposit accounting guidelines. European and African reinsurance services consist almost only of long-term, non-terminable contracts (without recapture or natural expiry), while other markets, such as Asia and USA, consist primarily of short-term reinsurance contracts. (Source: 10-K 2019 Filing)

The important thing to note here is that RGA has models and processes in place to try and make sure that they do not overextend in terms of risk, and that their strategies are successful in meeting increased risk with the appropriate amount of premiums/income. While there in the short to medium-term exists high amounts of volatility in terms of claims, payouts and risks, these become more muted over time. The following data measures deviation from linear trends in the company's mortality reinsurance, as an example.

(Source: Investor Presentation)

We can also look at the above-mentioned asset-intensive reinsurance business to see some of these considerations and where the company judges its policyholders to be in terms of risk.

(Source: Investor Presentation)

The fact is, we could go on four hours here just looking at the various market risks, structures, and specifics of how the company runs its operations. That is not the point, however. The point is an overview of what the company does, which you have here - and the fact that the company believes its models to be good enough going forward.

Historical results would tend to agree with this assessment, as the company has weathered multiple difficult financial situations without breaking stride.

(Source: Investor Presentation)

Shares have also continuously outperformed their peers and indices.

(Source: Investor Presentation)

This indicates that RGA indeed knows what they are doing.

So - to summarize. RGA is a reinsurance business making its money through premiums and incomes from offering reinsurance products and services across the globe. Operations are global, with a focus on NA/LATAM. The company has outperformed historically, and plays on a market dominated by very large players - of which RGA is the second-largest, characterized by extremely high entry-barriers, giving the company an attractive fundamental moat.

Let's move on to some recent results to see how RGA has weathered Corona.

Reinsurance Group of America - How has the company been doing?

(Source: 1Q20 Presentation)

So, a few things have happened during the corona crisis. While the company has of course been affected by corona, it's important to note that:

• Operations have been continuing to run smoothly with no disruptions to clients.
• The company has a very strong capital position, easy access to debt and over $700M on the balance sheet in cash and cash-equivalents (before the latest debt and stock offerings)
• The effect from Corona primarily impacted lower operating income due to higher mortality claims in the US, as well as the market providing lower investment incomes - none of the results were disparagingly below expectations, however, and Australia reported a modest profit.
• The net loss noted in key segments were from non-operating items such as investment impairments.
• The company has suspended all share repurchases.

(Source: 1Q20 Presentation)

Like every other responsible company, RGA has taken measures to make sure that employees stay safe and service continues to flow to customers. Looking at results on a more granular level, the quarterly unfavorable mortality claims primarily came from the American/LATAM segment - other segments such as Canada, EMEA, and Asia performed quite well with the exception of financial solutions as companies across the globe were rocked by Corona. Claims in the US alone were up to $54M for the quarter, concentrated into individual clients 70+ years and above.

There's ambiguity in just how much of this increase is Corona, and how much of this is the previously-discussed volatility in mortality rates. Future quarters will shed some light on this. What the company can confirm at this time, is corona-related claims at the very least in April of 2020.

So, while we have some impact on earnings, as of yet, this hasn't caused the company to in any way fall into "danger". Danger of not being able to fund operations, dividends, debt, or other fundamental qualities. Capital and Liquidity remain stellar.

(Source: 1Q20 Presentation)

We've spoken to the company's behavioral risk and liability profile. The company has further lowered higher policyholder behavior risk to where it only amounts to 4% of its consolidated reserves as of 1Q20. The company's investments continue to be well-diversified and a very high majority towards Investment-grade credit.

(Source: 1Q20 Presentation)

So while there have been overall effects and, most of all macro effects impacting company investment portfolios, with the entirety resulting in a GAAP-negative earnings result for the quarter, the overall tendencies for the longer term really haven't changed all that much. Most importantly of all, company liquidity and capital as well as leverage remain very strong. I believe these are the more important things to focus on when looking at recent results for the company.

Reinsurance Group of America - What are the risks?

Obviously, RGA comes with some risk. I'll point out some of the ones I see, but the company's risk presentation is very extensive with insurance risks, market risks, credit risks, capital risks, operational and strategic risks, and many others. I highly recommend that you read up on the matter prior to moving forward.

• Different regulations and legal frameworks makes comparisons trickier and can impact results. The above graphics shows just what sort of things RGA needs to consider in terms of geographical differences, and I've mentioned some of the differences in coinsurance and reinsurance policy trends we see here.
• The very basic insurance risk which comes from lower or negative earnings due to a greater amount of claims and related expenses. Corona has highlighted this risk not only in RGA, but in many insurance and reinsurance companies. While as of yet, there are no truly catastrophic or detrimental effects here, this could change going forward, both as a result of Corona and other, future pandemics.
• Market risk for a company like RGA remains very high, due to its exposure not only to claims and policies, but alternative investments, asset exposures, variable annuities, fixed annuities and other investments or products that the company offers. Investors may expect RGA to primarily deal with life reinsurance - while this is a major sector, the company also has a large amount of other products and investments that impact earnings.
• Client Exposure is one I'm particularly leery about in this climate, and a number of company geographies have less-than-ideal client exposure profiles where large parts of company profits originate from a select few number of clients. This isn't really the case in the company's core geography, but it is the case in other, smaller business areas where a few clients make up 40-60% of the entire geography.

The fact is that RGA is one of the more complex investments, risk-wise, I've engaged in for some time. It's one of those companies where you really want to spend an afternoon or more reading the 10-K's to understand exactly what you're buying, and don't just want to depend on articles or other's explanations. It's an exciting and qualitative company, but it does come with more complexity than other investments.

Reinsurance Group of America - What is the valuation?

As I'm writing this article, we've just finished a truly excellent week in stocks. As a result, a 60% undervaluation is no longer applicable to RGA. The undervaluation has tightened to "only" 53% in relation to my fair value price target for the company.

(Source: F.A.S.T graphs)

Much like other insurance companies, RGA historically does not trade at what we might otherwise consider a fair value estimate. RGA did however, go into Corona coming out from a valuation that was far higher than insurance/reinsurance companies typically see. Today, it trades at a blended P/E of ~9, which is above some insurance companies, but well below other companies. The yield here is no longer 3%+, but 2.8%.

What this means is that my initial position is already up 12% from lows. We can see that analysts do expect 2020 to become a year of horrors, with a 45% EPS drop. 1Q20 results should, i believe, be seen as a precursor to what's to come, with Corona-related claims ramping up in April and forward. The expectation is for RGA to turn around quickly in 2021 however, with a 74% recover.

These numbers are not to be as distrusted as some. FactSet analysts have a 91% accuracy ratio on a 2-Year basis (with a 10% margin of error) for the company, and while times are unprecedented, the fundamentals presented above coupled with the trends seen here lead me to believe that in the longer term, even if not exactly in 2021, the company will return to a certain profit as seen before.

(Source: F.A.S.T Graphs)

As the company has very rarely traded at fair value, we shouldn't expect it to do so now either. Potential upside based on market-assigned ~11 P/E comes to a long-term annual rate of return of over 25%. Even in the shorter term, and trading at expected results in relation to an 11X earnings ratio, returns are 31% for 2021. So while things in the short terms look poorly, as 11X 2020E earnings would indicate a share price of $80/share, these numbers should be extremely temporary.

My own price target for RGA is the very long-term ~10X earnings ratio, but based on 2021-2022 earnings, bringing the target price to around $150/share. This might seem high, but it was less than 5 months ago that the company traded well above that. While things have changed in terms of Corona existing and claims pressure likely increasing short term, it's nothing the company hasn't faced before - and what it in fact expects to face during the course of its normal operations.

So the current data:

Share price: $100.09/share

Dividend yield: 2.8%

Weighted average P/E-valuation (2019-2020): 9.29X

With my target for 2022 and the resulting yield (based on expected dividend growth) being:

Share price: ~$153/share

Dividend yield if purchased today/YoC with 2022E (based on 3.51/share, compared to 2.6/share now): 3.5%/2.2%

Potential upside from today's valuation: 52.68%

I believe my target is conservative enough that even if trading sideways or not fulfilling these expectations, investments made here will return impressive returns nonetheless. In my system, RGA is the last Financial stock at a class 1 designation still available at extreme (more than 20%) undervaluation. Ameriprise Financial (AMP) is now at 12.5%. Aflac (AFL) is now at 13.5%. RGA is A rated, combines an extremely high-quality score thanks to its rock-solid balance sheet, a top-tier safety dividend, a 20% LTM payout ratio, 16% 5-Year average dividend growth, and a 25-year dividend streak with a high opportunity score due to its valuation.

It is, as I see it, the most appealing class 1 financial stock available today. While there are companies that I own and that I would consider buying more of yielding more, including examples such as Toronto Dominion Bank (TD), insurance companies Prudential (PRU) and Principal (PFG), none of these come close to matching RGA's defensive qualities and undervaluation anymore.

Because of this, my choice is RGA - and this forms the basis of my current thesis here.

Thesis

I believe firmly that not at least looking into RGA at this valuation would be a severe mistake for any conservative dividend investor. The company is, as I see it, extremely likely to deliver considerable alpha from today's valuation in the future years. I've been taken bites of the company, adding to my own portfolio to slowly build my presence here.

The yield isn't fantastic for a financial. There's no denying that. You can get Insurance companies yielding 5-7% even today. They're good companies - but RGA, from a risk-management, credit quality, and historical perspective, is better. At least insofar as I see it, and how my system rates them, and I prefer investing in top-quality before second-class unless the yield spread is truly horrific. 2.8% compared to 4.5% isn't where I will be swayed by higher yield in exchange for slightly lower quality. I believe that the opportunity presented by RGA is one which will disappear, and which is disappearing as we speak. We can usually get some insurance companies for pretty cheap at great yields - but we're rarely able to pick up a company like RGA at any sort of discount.

Until now.

Therefore, my target represents a 53% upside from today's price, and I believe you'll be locking in a very favorable, lifetime yield at today's price if you choose to invest here.

Thank you for reading.

Stance

Reinsurance Group of America is a "BUY" with a 53% upside to 2022E earnings. I doubt we'll see this company trading at this valuation for much longer.

Analyst’s Disclosure: I am/we are long RGA, AFL, AMP, PRU, PFG, TD. 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.

While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment. I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles.

Comments

[Paperone75]

Any idea about the price has been pummeled until 67,56??

[BM Cashflow Detective]

@Paperone75
Well, I don't know the exact reasons either. Are there any? Only short and medium-term expectations are currently traded on the stock exchange. And they probably look very bad again. In my view, simply wonderful.

After that, the analysts cyclically lower their expectations again with the falling share prices. Somewhat unsurprising.
www.watchlistnews.com/...

Overall, I expect $RGA results to likely fail analysts' expectations next quarter as a result. From the perspective of the analysts as employees of the investment companies, this is probably a logical approach. Then the last optimists are driven out of the shares. I guess all of these investment companies already have capital for early purchases. The current sellers are just "maneuvering mass".

It is currently a very oversold situation. In my view, it is advisable to think long term and buy now countercyclically before others do. I like to buy into a lot of fear and doubt. Great discounts. Be greedy when others are afraid. That we already know. Now only one thing is decisive. Are you absolutely convinced of the long-term quality and durability of the business model? Then, in my opinion, there is only one sensible approach.

This is my point of view. Does that help you further?

[Paperone75]

Totally agree with you!

[BM Cashflow Detective]

@Paperone75 @Risk Professor @Tim Butler

"I guess all of these investment companies already have capital for early purchases."

Daily low on July 10th of our discussion $ 67.47.

Current price $ 83.74. Since then + 24.11%

This assumption has actually become more true in such a short time than I expected. It was almost a situation with an announcement.

The many years of experiences with Mr. Market's emotional behavior have paid off for me again. Obviously an advantage of age. I accepted his gift in time.

I hope you too.

[Paperone75]

This awful -6% is always consequence of a new peak in the new cases??

[Manatee Research]

Great article, thanks. Going to go check our their annual reports now ;).

[kewgo]

What’s the deal with RGA? Market is trending up and RGA is trending down pretty hard.

[The newbie invest]

I have to give kudos to Wolf for good articles, and also for having a focus on european stocks and markeds. I am a novice in stocks and articles from people with a clear philosophy is a good way to learn a little every day. I went in RGA around mid june, and I am fine with that. But in the two weeks following that purcase the share dropped to 83-84 $. I have not found any reason for this drop. What did I miss?

[Paperone75]

The cost of pandemic-related damages, either in life or in non-life fields, is higher than estimated.

[Paperone75]

Very well written article; RGA is one of my battle-horses, at the moment in the watchlist, but I have owned it some years ago. Maybe I could buy it again in the coming weeks.

[BM Cashflow Detective]

I have been heavily involved with my investments in the reinsurance industry for many years. Munich Re ($MURGY), Hannover Re ($HVRRF), Everest Re Group Ltd. ($RE), RenaissanceRe Holdings Ltd. ($RNR). In the past few weeks I have also noticed the blatant undervaluation of the Reinsurance Group Of America ($ RGA). So I opened a first position. Due to the variety of Corona offers, the position is unfortunately not as big as I would like it to be.

It should also be taken into account that this undervaluation naturally also has operational reasons. This weakness is clearly revealed in peer group comparisons. In the past five years, the return on equity has dropped from around the median to less than the median among competitors, suggesting that the company's historical competitiveness in operations is deteriorating. The return on invested capital has of course also decreased, as has free cash flows. RGA has relatively low profit margins and medium capital efficiency. While sales have grown faster than the peer median in recent years, the market for the share shows a P / E ratio that is only around the peer median. The change in the company's annual sales appears to be at the expense of earnings. RGA has relatively low profit margins and medium capital efficiency. The company is likely investing too much in a company with only medium returns. With the share price not rising so quickly, the market seems to assume that RGA's earnings will grow at about the same rate as those of its selected competitors and also does not appear to expect any significant improvement in returns below the comparative median.

I personally rate it quite differently. RGA is currently trading at a price-to-book ratio of 0.73. So I currently get almost 30% of the book value and the operational business for free. This is an extraordinarily good deal for me. I also like that this company has a strong competitive position in an oligopoly. In the long term, there is plenty of room for a catch-up potential in terms of return on capital, cash flows and margins. Like the author, I am convinced of the long-term potential of RGA. I don't see it as a big risk to invest in a company whose business model is managing big risks.

[Ton277]

Thanks for the article. It may be worth mentioning the recent $500M stock offering, along with the $600M debt offering which may need to be taken into calculations. I would also love to see more insider buying activity for this company.

[Risk Professor]

Agree with your assessment. Perhaps people have trouble understanding the complexities of reinsurance, and just stay away. Long RGA and PRU (also ATH).

[Bjorn Zonneveld]

Established a position today after taking profits in APPS

[Skip Kapur]

sheer coincidence. got into RGA just over the last few weeks. built a core position @ $90

good job Wolf, as always. excellent, really.

[labman106]

Will have to seriously look into RGA. Too bad the dividend is so low.
But on the flip side, the total return looks fantastic.
Thanks

[Tim Butler]

Wolf, thanks for your analysis and article on RGA. The performance on your undervalued stocks, per your prior recent articles, has been nothing less than spectacular. Perhaps you ought to post an article citing the tickers and prices, as of the date of publication of your prior articles, along with today's prices and appreciation percentage. What's astounding to me is the consistency in your cited companies. You did not just get lucky with one, two or a few, instead they are all up, and up big time. Thank You.