Primerica: Earnings Growth Regardless of the Economy
Jul/102
Primerica (NYSE: PRI - $20.98)
Introduction
I recently purchased shares of Primerica, which is a life insurance and mutual fund marketing company. Primerica was recently IPO’d by Citigroup (C) as part of Citi’s balance sheet reduction program. It has been one of the best performing IPO’s of the year so far. I believe Primerica’s shares are undervalued because investors are not factoring earnings growth that will be stronger than published Street expectations.
Company Background
Primerica provides financial products and services to middle-market America through a salesforce of independent producers. The company’s two main products are term life insurance and 3rd-party mutual funds. The company was formerly run by the legendary salesman A.L. Williams, who used inspiring motivational speeches to energize the salesforce. Sandy Weil bought the company in the early days of creating his Citigroup empire.
Main Investment Thesis
My main investment thesis is the current valuation does not factor earnings growth that will be stronger than the Street’s published expectations.
Why do I think earnings growth will be stronger than the Street estimates?
Prior to the IPO on April 1, 2010, Primerica entered into a reinsurance transaction with Citigroup that took about 80% of Primerica’s existing term insurance book off of its balance sheet and put it onto Citi’s balance sheet. This dropped the existing term life in-force block to drop from $650 billion to $130 billion. This also caused a one-time step down in Primerica’s earnings from to a $500 million annual run-rate to a $150 million annual run rate. Going forward, Primerica still has the same salesforce that was selling enough term life policies to grow a $650 billion term life block 3% annually. This salesforce producing the same amount of business can grow a $130 billion term life block at 51% annually.
How does 3% growth become 51% growth?
Primerica’s reinsurance transaction with Citigroup reduced the company’s existing block of term life insurance from $650 billion to $130 billion, but it did not diminish the capabilities of the company’s salesforce from adding new policies. In 2009, Primerica had a 10% lapse rate on its term life policies and added $80 billion in new term life policies. This led to a 3% growth rate.
In 2010, if will assume a continuation of the 10% lapse rate and another $80 billion of new term policies, the new $130 billion block of term life policies will grow to $197 billion or a 51% growth rate.
How does this growth translate into earnings?
The term life insurance division accounts for about 60% of the pre-tax earnings. I think this segment can grow 40% in 2011. The mutual fund sales can grow 5% a year, which assumes no in-flows and 5% market appreciation. Combined, I believe earnings in 2011 can be north $2.40 for a growth rate of over 20%.
Why don’t investors see this potential earnings growth?
Primerica’s potential earnings growth is hard to see because the reinsurance transaction with Citigroup is confusing and not what investors normally encounter.
Does Primerica have the capital available to support this level of growth?
Yes, Primerica has extra capital currently. The risk-based capital ratio is estimated to be north of 450%. Plus, the mutual fund savings division generates capital equal to its net income because it does not need capital for growth. Lastly, Primerica is only going to pay a token dividend while it is in this high growth mode.
Other Positive Parts of the Primerica Story
Plain vanilla business with no legacy issues – Primerica’s business is simple to understand. It is mainly a salesforce distributing straightforward term life insurance and a 3rd party mund funds. Term life insurance is one of the easiest forms of insurance for a life insurance company to manage on its balance sheet.
Potential for management to respond to improved incentives – Primerica’s management team should be motivated to show good results out of the gate from the IPO. This is an organization built on motivation and financial incentives. When the company was a subsidiary of Citigroup, I’m sure management had financial incentives, but the were still paid partly with options on Citigroup overall. It was impossible for them to move the needle on Citigroup’s stock. Now as an independent company, Primerica’s management team can directly impact the stock price by delivering strong results.
Ownership presence of Warburg Pincus – As minority shareholders, we are helped by Warburg Pincus’s ownership stake and presence on the board of directors. We can expect Warburg Pincus to focus on shareholders returns. With Warburg’s presence, we also expect management compensation to be under control and expect no value destroying acquisitions.
Leverage will add to returns – As part of the spin-off from Citigroup, Primerica took on some modest leverage at the holding company level that will improve equity returns. Since Primerica’s business seems stable and cash producing, I am comfortable the modest leverage will enhance returns without adding to the risk of financial distress.
Valuation
I believe Primerica is undervalued. At $21 per share, Primerica trades at 1.4x tangible book value and 9.5x the Street’s 2011 EPS estimates. These valuations are in-line with their life insurance peers. However, I believe the Primerica story is cleaner than the rest of the industry because they have fewer legacy issues (such as the investment portfolio at Aflac (AFL) or commercial real estate at Principal (PFG)) and are not dependent on the stock market for earnings growth (such as Prudential (PRU), Ameriprise (AMP), Hartford (HIG) or Lincoln (LNC)) Plus, with the reinsurance transaction with Citi, Primerica will have attractive growth for the next 5 years.
In addition, I believe Primerica could earn as much as $2.40 (or 22 cents more than consensus estimates) in 2011 as they regrow their term life book. As analysts increase estimates, the stock may attract attention from investors attracted to companies with rising estimates. The stock’s multiple could rise to 12x leading to a $29 stock price.
Risks
The main risks to my investment thesis on Primerica are: 1) I am overestimating the potential for earnings growth and 2) the market already recognizes the potential earnings growth and has appropriately priced the stock.
Primerica does have at least one potential issue with a reinsurance company facing financial difficulty. It has about $50 million reinsurance recoverable exposure to Scottish Re, which is in run-off. If they had to write-off this amount, it would be equal to a quarter of earnings. I believe the market would look through this issue if it happened.
I discount some commentators’ views that the Primerica salesforce is a risk. I believe the Primerica salesforce is a vital asset of the company. Yes, they recruit heavily and have high churn, but financial sales is not easy and not every recruit is able to make in sales. I think of Primerica’s salesforce as similar to Aflac’s. Both are high energy, depend on multi-level principles and have high turnover. While I wouldn’t succeed as a Primerica salesman, I admire the results of the organization. As Phil Fisher wrote, you want to own companies with outstanding salesforces.
Conclusion
I purchased shares of Primerica recently because I believe the shares do not factor in the potential earnings growth of the company. The business is a plain vanilla term life insurance business with some 3rd-party mutual fund sales. The earnings growth is not dependent on the stock market improving, rather, it just depends on Primerica’s salesforce delivering similar results to the recent past.
Disclosure: Long PRI, PFG
Gator Small Cap Portfolio Starts the Year Off Strong
Mar/102
The Gator Small Cap Portfolio has had strong performance in the first 10 weeks of 2010. Through March 15th, the Gator Small Cap was up 9.3% after fees compared to 7.8% for the Russell 2000® Index. This continues the portfolio’s strong performance from 2009 when it was up 81.6% compared to 25.2% for the Russell 2000® Index.
We had several strong stocks in the portfolio to start the year. Tivo is up 63% year-to-date on the back of a favorable court ruling awarding the company monetary damages for continued infringement of its patents by a competitor. Brink’s Home Security is up 29% after a larger competitor agreed to acquire the company. Also, DineEquity, the franchisor for IHOP and Applebee’s, is up 46% so far in 2010 after reporting stronger earnings and a better than expected outlook for the rest of 2010.
The Gator Small Cap Portfolio holds a concentrated portfolio of 30 stocks of companies with market capitalizations under $3 billion at the time of purchase. We attempt to own smaller companies with strong franchises and business models with favorable economics. We want to hold onto the shares for multiple years to allow the management teams time to compound the strong economics of their businesses. During 2009, we had 30% turnover portfolio holdings.
We believe the Gator Small Cap Portfolio is a unique offering because it is a small cap portfolio offered in separately managed account form. In addition, the portfolio is concentrated which is unusual for a small cap portfolio. Lastly, our account minimum is $100,000, which makes the portfolio available to individuals with modest assets. Our clients may choose any broker or custodian to hold their account. If the client does not have an existing relationship, most of our clients take advantage of our relationship with Fidelity Investments.
Due to the Gator Small Cap Portfolio’s investments in small company stocks and the portfolio’s concentration of holdings, we expect the portfolio to have a much higher degree of volatility than the overall stock market. Please only invest money which you will not need for five or more years. Past performance is not indicative of future results.
ICBA Calls for Restoring GSE Preferred Dividends
Mar/100
Last week, Camden Fine, President and CEO of the Independent Community Bankers Association, sent a letter to Secretary of the Treasury Timothy Geithner asking Treasury to restore the dividends on Fannie Mae and Freddie Mac preferred stock. Reading the letter, the community bankers feel like they were sold a bill of goods by Hank Paulson. It seems that Paulson’s book has enraged the ICBA, especially the fact that Paulson was proud to keep his promise to his “Chinese friends” for making them whole on GSE senior debt and MBS.
Let me know if it feels like the political rhetoric has died down regarding the GSEs.
March 12, 2010
The Honorable Timothy Geithner
Secretary of the Treasury
U.S. Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, DC 20220
Dear Secretary Geithner:
On behalf of the 5,000 members of the Independent Community Bankers of America I urge prompt Treasury action to remedy the status of preferred shareholders of the Government Sponsored Enterprises Fannie Mae and Freddie Mac. As the Administration and Treasury continue to control Fannie Mae and Freddie Mac in conservatorship and seek resolution to this unique GSE status, it is imperative that community bank GSE preferred shareholders are made whole to bolster capital and lending levels in this challenging financial and economic environment.
The abrupt action by then Treasury Secretary Henry Paulson to seize Fannie and Freddie through conservatorship was unjustly done in a way that needlessly crushed the value of GSE preferred shares, injuring over a thousand community banks that purchased these shares as a safe AAArated investment at the encouragement of their bank regulators. Since banks received special regulatory capital treatment for them and since banks are generally prohibited from investing in stock of other corporations, Fannie and Freddie preferred stock were important investments with full regulatory blessing.
Shockingly, Secretary Paulson fully acknowledges in his new book On the Brink that this action constituted an “ambush.” It took place shortly after he and the GSE regulators issued statements that supported the ongoing viability and capital levels of the GSEs in their current form as “shareholder-owned companies,” in order to “calm the market fears of a government takeover that would wipe out shareholders.” Now there is no doubt the government’s action was indeed an unjustified “ambush” structured in a way that continues to have detrimental consequences on many community banks that relied on the guidance of Treasury and bank regulators and were intentionally deceived on their Fannie and Freddie preferred holdings.
Americans expect and demand much better from their government and leaders. The lCBA urges the Treasury to help restore the value of the Fannie and Freddie community bank preferred share holdings to levels prior to the abrupt conservatorship of Fannie and Freddie. Preferred Fannie and Freddie shareholders should be compensated for the government’s action of eliminating all dividend payments and placing the preferred shares in a second position.
Rather than help stabilize the financial sector and boost lending, this government “ambush” further hurt banks’ capital levels, weakened the banks and reduced available credit. Such rogue changing of the rules governing preferred stock contracts also sent the entire market for financial preferred shares into a freefall, making it even more difficult for financial firms to raise needed capital. Notably, nearly $36 billion in Fannie and Freddie preferred stock was outstanding prior to their conservatorship. An estimated $15 to $20 billion was held by the banking sector and almost one-third of banks reported holdings including many Main Street community banks.
The Troubled Asset Relief Fund devoted $700 billion to help restoring financial sector credit and to increase lending with mixed use and results to date. However, if we truly want to help stabilize the financial sector, boost small business credit and economic growth, Treasury must also restore a reasonable value to GSE preferred stock so that affected banks can again increase their lending.
ICBA urges immediately restoring the dividend payments on Fannie and Freddie preferred shares and paying injured holders the amount of suspended dividends from September 7, 2008 on an estimated $20 billion in GSE preferred holdings. As the Administration works to remove the GSEs from conservatorship ICBA urges it be done in a way that will restore a reasonable value to the preferred shares. Helping restore the $15 to $20 billion in community banks capital value crushed by the unwarranted Treasury actions perpetrated on preferred shares can foster $150 billion to $200 billion in new lending as banks can leverage this capital.
Sadly, the Treasury and policymakers were forewarned of the distress and fallout that lmnecessarilv crushing GSE preferred shares would cause. For example, the attached letter dated August 271h, 2008 specifically warned of the community banks’ significant GSE preferred holdings that typically pay a fixed dividend and take priority over common stock. Unfortunately, Treasury chose to ignore the warnings when they turned the GSE preferred stock upside down when placing Fannie and Freddie into conservatorship on September 7, 2008. Mr. Paulson acknowledges in his book that he ambushed Fannie and Freddie shareholders in part to help satisfy the Chinese government, which owned billions of dollars in Fannie and Freddie bonds. Mr. Paulson notes that he called “my old friend Zhou Xiaochuan,” the head of the Central Bank of China, and China’s key financial leaders and said: “I always said we’d live up to our obligations.” ICBA believes it is now time to live up to United States obligations and help spur lending by compensating Fannie and Freddie preferred shareholders for the unjust actions of the government.
Sincerely,
/s/
Camden R. Fine
President and CEO
cc: The Honorable David Axelrod, Assistant to the President and Senior Advisor
The Honorable Lawrence Summers, Assistant to the President for Economic Policy and
Director, National Economic Council
The Honorable Eric Holder, Jr., U.s. Attorney General
The Honorable Michael Barr, Assistant Secretary for Financial Institutions
The Honorable Herb Allison, Jr, Assistant Secretary for Financial Institutions
The Honorable Barney Frank, Chairman, House Financial Services Committee
The Honorable Spencer Bachus, Ranking Member House Financial Services Committee
The Honorable Chris Dodd, Chairman, Senate Committee on Banking
The Honorable Richard Shelby, Ranking Member, Senate Committee on Banking
Best One Liners from Buffett’s 2010 Shareholder Letter
Mar/101
I always enjoy getting up the first Saturday in March to read Warren Buffett’s annual letter to Berkshire hathaway shareholders. Here are my favorite one liners from this year’s letter:
“I subtly indicated that I was older and wiser…I was just older.”
“If Charlie, I and Ajit are ever in a sinking boat – and you can only save one of us – swim to Ajit.”
“We shouldn’t expect our regulators to live up to their end of the bargain unless we live up to ours.”
“It’s clear that I failed you in letting NetJets descend into this condition. But, luckily, I have been bailed out.”
“There were three ways to cure this overhang: (1) blow up a lot of houses, a tactic similar to the destruction of autos that occurred with the “cash-for-clunkers” program; (2) speed up household formations by, say, encouraging teenagers to cohabitate, a program not likely to suffer from a lack of volunteers or; (3) reduce new housing starts to a number far below the rate of household formations.”
“Our first venture was also christened Berkadia. So let’s call this one Son of Berkadia. Someday I’ll be writing you about Grandson of Berkadia.”
“It’s been an ideal period for investors: A climate of fear is their best friend.”
“In the end, what counts in investing is what you pay for a business – through the purchase of a small piece of it in the stock market – and what that business earns in the succeeding decade or two.”
“It has not been shareholders who have botched the operations of some of our country’s largest financial institutions.”
“In my view a board of directors of a huge financial institution is derelict if it does not insist that its CEO bear full responsibility for risk control.”
“Charlie and I enjoy issuing Berkshire stock about as much as we relish prepping for a colonoscopy.”
“our recommendation in respect to the use of advisors remains: ‘Don’t ask the barber whether you need a haircut.’”
“P.S. Come by rail.”
If you didn’t see your favorite Buffett one liner from this year’s letter, please tell me yours and why in the comment section below.
Interesting GSE Article at Housing Wire
Mar/100
Paul Jackson, the publisher of HosuingWire magazine, wrote an interesting article about the lack of a political solution to the GSEs.
I find this article interesting because there is a growing realization that the path of least resistence for resolving the GSEs Conservatorship is to simply allow them to exit in their current form when they return to profitability.