Unum Group (UNM)

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Key Statistics

Enterprise Value = $9.192 billion

Operating Income = $1.576 billion

EV/Operating Income = 5.83x

Price/Revenue = .77x

Earnings Yield = 12%

Debt/Equity = 34%

The Company

Unum Group is a large international insurance company with a focus on life insurance and long-term disability. It operates throughout the world, but the main focus is their US & UK operation. It is an S&P 500 component.

Sentiment

Unum trades at a 50% discount from its 52-week high. Back in May, Unum missed earnings estimates by 1 penny and the stock dropped 17%. The earnings miss was due to issues in long-term care insurance, which triggered the reaction. The loss ratio in long-term care rose to 96.6% from 88.6%. Despite the rise in the loss ratio and problems in the long-term care segment of the business, operating income actually increased to $275 MM from $236 MM in the same quarter a year ago.

My take

For an S&P 500 component, Unum trades at a significant discount to the market and its peers in the industry. On a raw price/sales basis, the average for an insurance company is 1.35x. Unum, trading at .77x, trades at 57% of this valuation. Insurance is a fairly commoditized product with little differentiation. In this sense, my view is that insurance valuations are mostly a product of premium volume and underwriting standards, which are mostly homogenous in the large-cap universe.

Unum’s valuation is particularly unusual because Unum is actually a higher quality company than most of its peers. The average return on assets, for instance, for an insurance company is 1.31%. Unum delivers 1.65%. The market seems to think that the long-term care problems will overshadow the rest of the business, which doesn’t look to be the case.

My view on risk in the insurance business is simple: where there is smoke, there is fire. It’s not possible to know all of the risks in an insurance firm, but there are indicators. Insurance is a boring business. The main risk is that management with a short-term focus and an appetite for risk enters the picture.  The only way they can juice the returns and make the boring business exciting is by taking on unnecessary risk. This usually shows itself through rapid growth in earnings and revenues combined with higher debt levels and signs of financial distress.

For insurance companies, my focus is on purchasing good relative value and trying to reduce the odds that I’m buying into a nightmare scenario. A good example of a nightmare scenario would be AIG, who decided in the early 2000s that they didn’t want to be a boring old insurance company and instead wanted to be cool and become a high flying Wall Street gunslinger. We know how that worked out. Another example of a nightmare scenario would be GEICO in the 1970s, who loosened standards to fuel growth. This lead to a disaster that almost killed the company. This created a situation where Warren Buffett was able to move in, buy 1/3 of the company for $45 million, and use his influence to save the company. The rest is history.

With a low debt/equity ratio and a Piotroski F-Score of 7, there are no signs of financial distress in UNM. Top line revenues are only up 8.8% since 2013 and growing at a steady, organic pace. This implies that they aren’t playing it fast and loose with their underwriting standards and sacrificing risk management for business growth. Overall, this doesn’t strike me as the risky insurance firm that is going to blow up in the future.

The over-reaction to the penny miss looks extreme to me for an insurance company that is otherwise performing well. Being in the insurance business and investing heavily in short-term fixed income products, I also expect Unum and the insurance industry as a whole to benefit from rising interest rates. The economy is performing well, and unemployment is extremely low (for now), implying that premiums will be sustained.

Overall, Unum isn’t the most exciting deep value opportunity in my portfolio, but I think it presents a decent value proposition. It is a high-quality insurance company trading at a 57% discount to its peers and 50% off its 52-week high.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.