Lincoln National Corporation (LNC) continues to be a beaten-down financial stock. Since the start of the year, the shares have traded down by 43%, as fears and concerns over the pandemic still linger. However, I believe that the stock has fallen too far, and that the risks are more than priced in. In this article, I evaluate what makes this stock an attractive investment at the current valuation; so let’s get started.
A Look Into Lincoln National Corporation
Lincoln National Corporation is a financial services company that provides life insurance, annuities, and retirement plan services. It was founded over a century ago, in 1905, with the endorsement of Abraham Lincoln’s son, Robert Todd Lincoln. Today, it is ranked #188 on the Fortune 500 list by revenue and #22 by assets, and serves over 17 million customers. In 2019, the company generated over $17B in total revenue.
COVID-19 has undoubtedly been challenging for the company, as claims related to the pandemic reduced earnings by $0.65 to $0.75 per share in the latest quarter. EPS in the latest quarter was $0.97, which represents a 59% YoY decline. Management estimates that for every 10,000 COVID-19 deaths, the company should expect a $10 million hit to earnings.
Looking into this morbid financial statistic, I wanted to calculate what LNC’s EPS hit may look like for the third quarter that just ended. Using the red line in the CDC graph below, I estimate the average number of daily COVID-19-related deaths to be 850 for the months July through September.
When multiplied by the 92 days in the quarter, I arrive at an estimated 78,200 COVID-19-related deaths during Q3 alone. Applying management’s $10M per 10K deaths estimate, this comes out to an earnings hit of $78.2M. Then, dividing the $78.2M by the 193.2M total current shares outstanding, I arrive at a $0.40 YoY hit to EPS, which is less than what the company saw during the second quarter. As such, I see this as being an encouraging sign for LNC’s Q3 results, and I expect to see a sequential improvement over the Q2 EPS. However, we are not out of the woods yet, as the infection rate and deaths during the winter season will be largely determined by how well the spread is contained.
In the meantime, I see management adjusting well to the current environment. There are a number of expense management initiatives underway, with some of it being permanent cost savings to the run rate, as management noted during the last conference call:
“Expense management also remains a key focus in the near-term with Liberty synergies of $125 million nearly achieved, digital savings on track for $40 million to $50 million this year and progressing towards our $90 million to $150 million target and we have also made significant progress on our third savings initiative, an additional $100 million this year to help offset near-term pressures.
We expect to maintain this $100 million going forward by leveraging virtual sales capabilities, sustained increased workforce productivity and capitalizing on the recent acceleration in digital adoptions by both advisers and customers, all of which enable us to conduct business more efficiently.”
I’m also encouraged to see that LNC maintains a strong balance sheet, with an RBC (risk-based capital) ratio of 444%, which is well in excess of the 250% standard set by the NSCC (National Securities Clearing Corporation). In addition, 96% of LNC’s debt investments are investment-grade rated.
As seen below, LNC has delivered solid returns on its investment portfolio, averaging 9.7% annualized returns from 2012-2019. While the investment portfolio saw a decline during the last quarter, I expect to see a rebound in Q3, as the markets have generally recovered.
(Source: Company Earnings Presentation)
Overall, I see LNC as being a shareholder-friendly company. As seen below, management has driven earnings accretion through active share repurchases on the open market. Since 2015, the total number of shares have been reduced by 21%, equating to an annualized reduction of 5% per year.
(Source: Created by author using Seeking Alpha data)
In addition, the current $0.40 quarterly dividend is well covered, with a payout ratio of just 41% (based on Q2 EPS of $0.97). As such, I find the 4.7% dividend yield to be attractive, especially when compared to the current low yield environment, and the low 1.5% yield of the S&P 500 (SPY).
Based on the analyst estimates below, LNC is expected to post strong annual EPS growth over the next two years. Based on these estimates, the forward P/E for 2020 sits at just 4.4 and it lowers to 3.2 in two years, if the growth estimates are realized.
With this in mind, I wanted to calculate what the PEG ratio is, with the following inputs:
- Price: $34.29
- EPS: $7.77 (2020 EPS Estimate)
- EPS Growth Rate: 9.65 (using the more conservative 2022 growth rate)
With the inputs above, I arrive at a PEG ratio of 0.46. Using a PEG ratio of 1 as a standard for fair value, the shares appear to be deeply undervalued.
As seen below, at the blended P/E of 4.6, the shares are currently trading well below the 10-year normal P/E of 8.6.
(Source: F.A.S.T. Graphs)
Analysts appear to agree that the shares are undervalued, with a consensus Buy rating (score of 3.6 out of 5), and an average price target of $44.64, which gives the shares a potential 30% upside from the current price.
Lincoln National Corporation is a well-run financial services company that has seen difficulties brought upon by COVID-19. While Q2 was challenging, I estimate that EPS will improve sequentially in Q3, as demonstrated by my calculation. In the meantime, I’m encouraged by management’s cost-saving initiatives, some of which appears to be a part of the permanent run rate going forward.
LNC maintains a strong investment portfolio and has a track record of returning capital to shareholders. In addition, the 4.7% dividend remains well-covered. Lastly, I see the shares as being undervalued at the current price, with a potential 30% upside from the current valuation.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.
Additional disclosure: This article is for informational purposes and does not constitute as financial advice. Readers are encouraged and expected to perform due diligence and draw their own conclusions prior to making any investment decisions.