3 More Years And The Profits Will Come bulentumut/E+ via Getty Images
In our previous coverage of Lemonade, Inc. (NYSE:LMND) we discussed the improving loss ratios which suggested that the company was making modest improvements in its journey. While there was a timeline in sight and LMND could potentially reach a profit inflection, there was hardly any reason to buy the stock. We went with a "hold" rating. The stock has moved higher since then and even outperformed the SPDR® S&P 500® ETF Trust (SPY).
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We go over the latest results and tell you why we are now switching to a Sell rating.
Q2-2024
From a bull perspective, LMND was once again able to deliver the revenue growth that everyone craved. The 16.6% jump was about in line with where analysts set the bar. But on everything else, things did not look quite as good.
Total expenses were up by $6.6 million year over year and this was despite some favorable loss and loss adjustment numbers. The company cut back on technology development expenses but sales and marketing increased by about 48.3%. This is quite an increase and goes to show that even LMND's cheap policies are not selling themselves these days. If you need a 50% increase in marketing expense to drive 16% top line growth, you know you are in some deep trouble. This is also coming fairly late in the game where LMND should be developing economies of scale. It is also coming after book value has been crushed after years of losses. By itself, it is a fairly worrisome trend. But there are other issues as well. The top line growth is actually weaker than it looks as net investment income rose far faster than total revenues. The interest rate hikes flowed through to the LMND portfolio with a lag, and we are still seeing increases from that front. Finally, the loss in this quarter was a stunning $57.2 million in total. This increased from the previous quarter, something you can quickly decipher by just examining the year-to-date total of $104.5 million.
Outlook
Analysts have pulled back estimates after the Q2-2024 number.
There are numbers out there until 2026 and all of them show losses.
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One irony here is that the EPS estimate is lower as it is distributed over a larger share count.
In all likelihood, share count should be over 75 million by year-end 2026 and that helps show a lower loss per share. LMND's bigger issue though is where exactly does its equity erosion end?
The slope of hope above is fairly steep and appears to moving towards its final destination unabated. The little bump you see around July 2022 is the Metromile acquisition. But that jump in equity was also engineered by a big share issuance. You can see this number here on the 10-Q.
10-Q Q2-2024 LMND
Keep in mind that this number is also boosted by Goodwill and Intangibles. When you look at tangible book value per share, even that bump is missing.
We have moved from circa $18 down to $8.422. If you add up the expected losses of the next 10 quarters (until year-end 2026) you knock out another $5.00 of tangible book value. The question is always the same. What would you pay for a mildly profitable LMND? So, assuming it reached those profits in 2027 (we doubt it), what is your best-case scenario? A realist would say 1X tangible book, which would put it near $3.50. An optimist would perhaps say 2X tangible book which would still give the stock 60% downside. A knowledgeable investor might point out that there will be some serious limitations on how many dollars of policies this company can write with only $250 million of equity. We have not even factored in here the problems of declining interest income. LMND will take two hits on this front. A declining portfolio size and interest rate cuts which look certain for late 2024 and early 2025. At this point with the stock trading well over 2.0X tangible book, we are firmly convinced this is a time to Sell and not look back. One risk to the bear thesis is a huge equity issuance. LMND trades for over 2.2X tangible book, and we think the incentives are fairly high for a stock issuance.
If they could use the current market euphoria to issue 20 million shares at even $15 per share, that would add $300 million to total equity. It would also boost tangible book value back to almost $10 per share. So the equity window remains open and this is one reason to not get extremely bearish. Paradoxically if the market punishes the stock well below tangible book value, the equity window will have closed and LMND will have to make some really hard choices with the policies it chooses to write.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult a professional who knows their objectives and constraints.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.
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