Shazia Sultana ...
Shazia Sultana Sultana.5@buckeyemail.osu.edu 614-789-9780
Company Description : Lincoln National Corporation
(Lincoln) is a holding company, which operates multiple insurance and retirement businesses through subsidiary companies. Through the Company‟s business segments, it sells a range of wealth protection, accumulation and retirement income products and solutions
Investment Thesis: My buy recommendation is based on my belief that LNC's valuation is attractive, with the stock trading at a discount to its peer group. I believe LNC has made strides in improving its balance sheet strength and financial position in recent periods.
Despite an uncertain regulatory climate and low interest environment, Lincoln National Corp is poised to take advantage of the gradual economic recovery. It is attractive investment due to following factors:
Recommendation: BUY
Stock: Lincoln National Corp (LNC)
Date of report : Nov 29, 2011
Current Stock price : $18.52
12 Month Target price: $27.72
Upside Potential: 49.67%
Projected return (Inc. Div): 51%
Well positioned to withstand low interest rate environment from both Statutory and GAAP perspective
Strong balance sheet and capital generation
Effective risk management reduces exposure to credit and equity markets risks
Strong capital margin positions Lincoln for economic stress and continued return of capital to shareholders o 60% increase in dividend o $375 million of share repurchases year-to-date
12 Month Price Performance
Risks to my recommendation:
High Dependence on Economic Indicators: o Low GDP Rates o Low Interest Rates o High Unemployment Rates
Adverse credit and capital market conditions
Any downgrade in financial strength and credit rating
Regulatory Impact: o Federal Tax Legislation o Dodd Frank Wall Street Reform o Regulation XXX o Actuarial guideline38
Catalysts:
Accretive Acquisitions
Announcement of Additional Equity offering
Expected GDP growth
Financial Data (FY2011)
52 Week Price Range 13.75 -32.68
Market Capitalization 5.30 b
Diluted Shares Outstanding 319.21(m)
Dividend Yield 1.80%
EPS (ttm) 3.13
Table of Contents
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Company Overview
Lincoln National Corporation (LNC) a publicly traded holding company, which operates as Lincoln
Financial Group, provides multiple insurance and retirement businesses through subsidiary companies such as Lincoln National Life Insurance and Lincoln Life & Annuity Company of New York. LNC, through its business segments, offers a wide range of wealth protection, accumulation and retirement income products and solutions.
The products include fixed and indexed annuities, variable annuities, universal life insurance (UL), variable universal life insurance (VUL), linked-benefit UL, term life insurance, mutual funds and group life insurance. Lincoln Financial Network (LFN) and LFD (LFD) are the Company‟s retail and wholesale distributors. As of December 31, 2010, LNC had consolidated assets of $193.8 billion and consolidated stockholders‟ equity of $12.8 billion.
Lincoln classified its products and services into two operating businesses and report results through four segments as follows:
Business
Retirement Solutions
Corresponding Segments
Annuities
Defined Contribution
Insurance Solutions Life Insurance
Group Protection
Business Segments Analysis
Retirement Solutions
The Retirement Solutions business provides its products through two segments: Annuities and Defined
Contribution. Products for both segments are distributed through a wide range of intermediaries including both affiliated and unaffiliated channels of advisors, consultants, brokers, banks and wire houses.
Retirement Solutions – Annuities
The Retirement Solutions – Annuities segment provides tax-deferred investment growth and lifetime income opportunities for its clients by offering individual fixed annuities, including indexed annuities, and variable annuities. Total annuities deposits are comprised of 77% variable annuities and 23% of fixed annuities
2010
Segment Performance
Total annuity deposits of $10.7 billion were up
3% from the prior-year due to 15% increase in variable annuity partly offset by a 24% drop in fixed annuity deposits. Total net were
$3.5billion, about 9% drop than a year ago. The
Individual Annuities segment reported income
Key Drivers
Income from operations for this segment increased primarily due to higher insurance fees on variable account and net investment income, due to higher average fixed account.
The increase in income from operations was partially offset by an increase in the allocation
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Q3 11 from operations of $484 million versus income from operations of $ 353 million in the year-ago period, amounting for a significant 37% increase.
The Individual Annuities segment reported
28% rise in income from operations of $162 versus income from operations of $126 million in the year-ago period.
Improved lapse ratio, a measure of effective marketing strategies, for annuity product.
Total annuity deposits of $2.7 billion were down
9% from the prior-year quarter due to a drop in fixed annuity deposits. Indexed annuity deposits fell 45.9% from 3Q10 to $462 million, while fixed annuity sales dropped 11.5% to $92 million while variable annuity deposits of $2.2 billion were up 7%. of overhead costs during 2010 as a result of disposal of Lincoln UK and Investment
Management businesses.
Annuity segment earnings of $161.6 million were boosted by a positive DAC adjustment and a tax benefit.
Growth in the VA business was offset by a decline in the fixed and indexed annuity products. Results benefited from growth in sales as well as lower withdrawals due to the drop in account values and in-the-money guarantees. Management attributed the weakness in the indexed business to a shift in distribution focus towards variable annuities.
High VA living benefit guarantee exposure
($41.1b as on 09/30/2011 which represents
64% of total VA AUM)
In 3Q11, LNC reported a VA hedge program loss of $82.6 million (not included in operating EPS) following losses of $9.8million and $19.0 million in the previous two quarters.
Segment Outlook
Considering the strong net flow, high earnings and continuous growth in variable annuity business as indicated by the Q3 2011 outcome, I expect that variable annuity would be driving the results of annuity segment. Fixed and indexed annuity sale would remain weak due to low rates and weak equity market.
Results should improve if the market recovery in 4Q11 sustains I also expect that LNC‟s earnings and capital will be more volatile than peers due to Lincoln‟s $41.1 billion exposure of equity –based living benefit guarantees (64% of total VA AUM) is prone to substantial earnings volatility and balance sheet risks.
Lapse Ratio for annuity products
2010
7%
2009
8%
2008
9%
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Retirement solutions-Defined Contribution
The Retirement Solutions – Defined Contribution segment provides employer-sponsored variable and fixed annuities, defined benefit, individual retirement accounts and mutual-fund based programs in the retirement plan marketplaces.
Total defined contribution deposits consisting of 36% Variable annuities, 19% fixed annuities and 45% mutual funds.
2010
3Q11
Segment Performance
Total deposits increased from
$4952(m) to $5301(m) with an increase of 7% over last year that is mainly attributed to 6% increase in VA deposits.
Income from operations increased to
16% for 2010.
Lapse rate is negatively affected due to overall shift in business mix toward products with lower returns.
DC business generated earnings of
$40.5 million. Total deposits increased
15.4% from 3Q10 and 21.4% sequentially to $1.5 billion. Positive flows of $329(m)
Key Drivers
Income from operations for this segment increased due to the higher net investment income and higher insurance fees driven primarily by higher average daily variable account values . The increase in income from operations was partially offset by higher underwriting, acquisition, insurance and other expenses, due to
Investments in strategic initiatives related to updating information technology and expanding distribution in mid-large and small case segments
Favorable DAC adjustment of $3(m).Strong deposits and a decline in withdrawals lifted net flows, which were positive for only the second time in the past five quarters
Lapse Ratio for DC products
2010
14%
2009
12%
2008
13%
Segment Outlook
My long-term outlook for the DC business is positive, but the weak economy and persistent high unemployment would be critical factors to challenge near-term plan enrollments and deferral rates. I expect flows to remain modest, as Sales results are pressured by the weak economy and possible disruption due to the rollout of a new record keeping platform and upgrades to LNC technology platform.
Insurance Solutions
The Insurance Solutions business provides its products through two segments: Life Insurance and Group
Protection. The Insurance Solutions – Life Insurance segment offers wealth protection and transfer opportunities through term insurance, a linked benefit product and both single and survivorship versions of UL and VUL, including COLI and BOLI products. The Insurance Solutions – Group Protection
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segment offers group life, disability and dental insurance primarily in the small- to mid-sized employer marketplace for their eligible employees.
Insurance Solutions – Life Insurance
The Insurance Solutions – Life Insurance segment, with principal operations in Greensboro, North
Carolina and Hartford, Connecticut and additional operations in Concord, New Hampshire and Fort
Wayne, Indiana, focuses on the creation and protection of wealth for its clients through the manufacturing of life insurance products. The segment generally has higher sales in the second half of the year than in the first half of the year. Approximately 44%, 44% and 46% of total sales were in the first half of 2010,
2009 and 2008, respectively
2010
Segment Performance
Income from operations for this segment decreased by 10% as income declined from
$569(m) to $513(m) with 26% increase in benefits
Key Drivers
$83 million unfavorable prospective unlocking of DAC, VOBA, DFEL and secondary guarantee life insurance product reserves and higher death claims. Lincoln issued $500 million of long-term debt (7% coupon) and secured commitments for $2 billion of new LOCs (maturing in 2015) to replace LOCs maturing in 2012 that is dilutive to earnings due to higher borrowing costs
3Q11 The individual life segment earned $131.6 million in 3Q11.Total individual life sales increased 4.4% from 3Q10 to $154.9 million.
Strong growth in MoneyGuard (+81.1%) and
VUL (18.5%) more than offset weakness in term life (-22.5%) and COLI and BOLI (-57.9%)
Results were adversely affected by DAC, continued conversion of valuation platform and reserve adjustments.
Segment Outlook
I believe returns on LNC‟s in-force block will be pressured by low interest rates, higher excess reserve funding costs and low margins on older UL blocks. I expect robust sales growth in MoneyGuard as the shift from Term to UL continues. I also expect further compression in interest sensitive spreads due to low interest and management‟s inflexibility to reduce crediting rates.
Insurance Solutions – Group Protection
The Insurance Solutions – Group Protection segment based in Omaha, Nebraska offers group nonmedical insurance products, principally term life, disability and dental, to the employer marketplace through various forms of contributory and noncontributory plans. Most of the segment‟s group contracts are sold to employers with fewer than 500 employees.
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2010
Segment Performance
Income from operations for this segment decreased by 42% from $124(m) to $72(m), with a 43% drop in non medical product-line.
Key Drivers
Unfavorable total non-medical loss ratio of
76.2% attributable primarily to unfavorable claims incidence, termination experience on long-term disability business and adverse mortality and morbidity margins on life business.
3Q11 Business earned $27.8 million with total revenues rising 6.2%. Non-medical net earned premium grew 7%, sales were up 9%
The overall loss ratio declined from 79.2% in 3Q10 and 73.4% in 2Q11 to 71.8%, driven primarily by a recovery in disability margins.
Segment Outlook
Total group insurance sales grew 9.2% with life up 29.9%, disability up 21.2%, and dental down 40.7%.
However, the third quarter is not a meaningful indicator of overall sales activity as it typically accounts for less than 20% of annual production (4Q is the company‟s highest quarter). Year-to-date, group benefits sales are down 4.8%.I expect group insurance sales to remain modest industry-wide due to the weak economy and limited new plans being put out to bid. Group insurance business offers attractive long-term growth potential, and I expect management to attempt to grow the business via acquisitions.
Besides adding scale, acquisitions in the group market would help diversify LNC‟s liability profile and reduce its earnings and balance sheet sensitivity to equity-based products such as variable annuities.
Segment Mix
The life insurance is the highest contributing line of business in deposits, accounts, cash flows, revenue and earnings. The total deposits have increased 6% with highest contribution from life insurance and defined contribution segments. Total net flows decreased by 14% with 26% increase in life insurance whereas the rest of the segments have fallen by wide margin. Account values have increased by 11% with
14% increase in annuities,10% increase in defined contribution and 6% increase in life insurance segments. I expect LNC's top-line trends to improve, driven by the strength of its distribution capabilities and product enhancements, although low interest rates could be a headwind.
Business Segments-% of Earnings
Annuities Defined Contribution Life Insurance Group Protection
6%
Business Segments-% of Revenue
Annuities Defined Contribution Life Insurance Group Protection
19%
36%
26%
10%
46%
12%
45%
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Business Strategy & Competitive Advantage
Lincoln primarily pursues a three-pronged strategy consisting of (1) growth on, (2) protecting margins, and (3) risk-off. LNC views top-line growth as a partial antidote to low interest rates and seeks to grow its small to mid-sized retirement and group voluntary benefits businesses. Sufficient scale, financial strength and financial flexibility are becoming prerequisites for sustainable growth in the life insurance industry.
Multiple Distribution Platforms
Lincoln has a solid, competitive advantage in distribution platforms; wholesale distribution through
Lincoln Financial Distributors, retail distribution through Lincoln Financial Network, and worksite sales and service organizations found in both Group Protection and Defined Contribution businesses. During the third quarter 2011, At LFD, LNC boosted sales by 8% among top 20 strategic distribution partners -
Lincoln Financial Network has increased net active producers to more than 8,000, which helped LFN to meaningfully contribute to Lincoln's sales results in the quarter
Business Mix Shift
LNC derives approximately 43% of its earnings from spread based businesses (fixed annuity, UL, and pension plans).As a strategic initiative, LNC is emphasizing more stable products such as Defined
Contribution and Group Protection vs. longer duration, more capital intensive business lines. I think investors will welcome this shift as more stable earnings streams based on underwriting margins and fee earnings on account values without capital volatility are becoming increasingly desirable in the current environment. Further, LNC is introducing new product lines to target specific customer‟s segments.
Lincoln introduced simplified and capital efficient products in Annuities segment including recent product enhancements such as Fixed Index Annuity GLWB (LINC Edge) guaranteed lifetime withdrawal benefit on fixed product and a new fee-based variable annuity( Variable annuity i4LIFE) for the registered investment advisor market. During third quarter 2011, LNC launched a critical illness product to round out our voluntary benefit offerings.
Financial Flexibility
I believe LNC is amply capitalized and well positioned to withstand low risk environment from both
Statutory and GAAP perspective. Over the past year its comprehensive capital plant, allowed to raise or retain close to $3 billion in capital, which gives enough financial flexibility to invest in growth activities, as well as to help protect the company in the event that the fragile recovery falters. Lincoln ended the year
2010 with a risk-based capital (“RBC”) ratio – an important measure of an insurance company‟s capital position – of 490%, and approximately $700 million in cash at the holding company, both historically high levels for the company.
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RBC Ratio
2007
416%
2008
462%
2009
450%
2010
490%
Debt-to-capital 30.80% 34.30% 31.50% 32.60%
%of Total debt Maturing in next three years 25.20% 23.70% 16.70% 14.80%
Commercial paper as % of total debt 5.10% 5.70% 1.80% 1.70%
Financial flexibility metrics at LNC: RBC Ratios Have Steadily Increased over the Past 3 Years, Debt
Levels Unchanged from ’07, Modest Near-Term Refinance Risk, and Commercial Paper Use Reduced
Credit Ratings
During May and June of 2010, Moody‟s Investors Service (“Moody‟s”), Fitch Ratings (“Fitch”) and A.M.
Best Co. (“A.M. Best”) all improved their outlook on LNC to stable from negative, and Standard &
Poor‟s (“S&P”) outlook remained stable. As a result of our focus on building strong liquidity and capital positions and improving earnings in our core businesses, Moody‟s improved its outlook on our company to positive from stable on June 22, 2011.
Recent Important Events/News:
In the third quarter of 2010, LNC announced a plan to repurchase up to $125 million of its common stock. During the course of 2011, Lincoln repurchased $375 million of its shares, paid down $250 million of debt and boosted its common dividend by 60%.
In January 2010, LNC closed the transaction announced in August 2009 to sell its asset management division Delaware Management Holdings to Australia-based bank Macquarie Group for $428 million in cash.
In May 2011 LNC announced new structure for its Insurance and Retirement Solutions business under the leadership of Mark Konen , President of Insurance and Retirement Solutions for Lincoln
Financial Group. Since then three important executive appointments have been made, namely Jamie
DePeau as Corporate Chief Marketing Officer and Jen Warne SVP as Head of Talent in September
2011 and John Morabito as Head of Institutional Retirement Solutions Distribution in November
2011
In Nov 2011, LFD (LFD), the wholesale distribution subsidiary of Lincoln Financial Group and
Primerica, Inc. the largest independent financial services marketing company in North America, announced that they have formed a strategic alliance enabling approximately 82,000 of the company's
92,000 licensed representatives to offer Lincoln's Fixed Indexed Annuity product as part of its suite of retirement planning solutions.
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Investment Thesis
Fundamental Drivers
In addition to strong fundamentals, strong capital adequacy and liquidity driven by the strength of its distribution capabilities and diversified business mix; following drivers further portray the Company as an attractive investment opportunity.
Positive Operating Trends
In the face of economic challenges and market volatility, third quarter 2011 produced strong operating results with increases in operating income, operating revenues, deposits and flows, particularly good momentum in Group Protection and Defined Contribution businesses. The operating trends include sales increases and positive net flows in nearly every business, resulting in $5.5 billion of deposits and $2 billion of net flows, a 6% increase in operating revenues and a 54% increase in income from operations.
Solid New Product Development & Enhancement
LNC‟s new product pipeline is encouraging and is believed to be its strongest in quite some time. Over the next couple of years, these new products will help to offset some of the recent pricing pressure felt by the Company, to stabilize or improve market share, and to potentially increase investor confidence. A wide-ranging platform of products will help the firm compete for baby boomers' retirement-saving needs.
New product approvals and introductions began contributing to sales growth during the fourth quarter and will continue to drive growth in fiscal 2012.
Attractive Total Return Investment
LNC offers an attractive total return on investment. LNC‟s Annual Report “One of the Company‟s primary goals is to provide a return to our common stockholders through share price accretion, dividends and stock repurchases” In addition to significant upside potential on the value of its shares, the Company currently offers a 1.8% dividend yield. Additionally, the Board of Directors authorized the repurchase of
$375 million shares year to date with 60% increase in dividends.
Effective Risk Management
Given low rates, LNC entered into $1.3 billion of Treasury locks with an implied yield of 6.45% and extended the duration of the life portfolio. In order to protect aggregate margins LNC s actively re-pricing products as needed to reflect market conditions. Also, LNC has increased holding company cash, reduced reliance on short-term funding and made hedging programs more robust (by hedging more variables and/or adding macro hedges). Investment portfolio risk appears manageable as well, with reduced exposure to structured securities and minimal European holdings. Strong capital margin and effective risk management initiatives reduces LNC‟s exposure to credit and equity markets risks
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Economic Analysis
LNC has an approximate 1.5% market share of the $724 billion U.S. Life Insurance Industry. According to the Federal Reserve, the Life Insurance and Annuities industry is one of the largest sources of investment capital in the United States, with an estimated $4.8 trillion in financial assets in 2011. In the five years to 2016, the industry is expected to grow by an average annual rate of 4.0% to $882.9 billion.
Demographic Trends
According to the US Census Bureau, the segment of the general population of retirement age (aged 65 or older) is expected to increase from 12.4% in 2000 to 13.0% in 2010, 16.3% in 2020, and 19.6% in 2030.
In addition, the retiring baby boomers in the country are expected to be redirecting their investment assets for retirement purposes. Changing demographics in the U.S. will serve to increase demand for LNC products going forward and provides tremendous opportunity for Retirement and Insurance products.
Per Capita Disposable Income
The rate of demand for life insurance and annuity products is strongest within higher income brackets.
Life insurance and annuities are not a necessity, which is similar to other discretionary purchases. As a result, demand increases when disposable income rises. Whole life insurance and fixed annuities often require high up-front costs, increasing the need for disposable income. Most of the LNC products are also positioned as retirement and tax-preferred vehicles, increasing the demand among affluent individuals who want to preserve capital and avoid high tax rates. This driver is expected to rise over 2011.
Number of employees
According to the US Census Bureau, the segment of working age people (ages 20 to 64) in the general population is expected to increase from 59.0% in 2000 to 60.0% in 2010; the percentage is then projected to decrease sharply to 57.2% in 2020 and 54.2% in 2030. Growth in the total work force increases demand directly through employer-sponsored group insurance and annuity programs and indirectly as more workers demand a greater number of individual life insurance and annuity products
Unemployment Rate
High unemployment should pressure enrollment levels and increase product loss ratios that could be unfavorable for earning outlook for the Group Protection Business.
Projected national unemployment rate
Unemployment Rate (%)
10
8
6
4
2
0
2010 2011 2012 2013 2014 2015
Projected national unemployment rate
Unemployment Rate
(%)
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Yield on 10-year Treasury bond
The major fundamental negative in the current environment is the low level of interest rates. If rate remains at current levels of 2.2%, portfolio yields will gradually decline, pressuring investment income and likely resulting in downward revisions to EPS estimates. Prolonged low rates could also result in balance sheet charges if companies are forced to reduce discount rates for reserves or write off DAC and/or goodwill we believe results for LNC, are the most sensitive to sustained low interest rates, Besides their impact on earnings, low rates are likely to continue to weigh on investor sentiment on the group, limiting P/BV multiple expansion. While low rates are a headwind for earnings, it is not expected to impact balance sheet in the near term. LNC derives approximately 43% of its earnings from spread based businesses (fixed annuity, UL, and pension plans), and a prolonged period of low interest rates would pressure results. LNC is particularly vulnerable to low rates as a significant proportion of its liabilities are already at minimum crediting rates, which limits management‟s ability to reduce crediting rates
Dow Jones Industrial Average
Although life insurers‟ balance sheets are less susceptible to market volatility than previously, earnings remain highly sensitive to rates and equity returns. As LNC has shifted business mix toward fee-based accumulation products (such as variable annuities, variable life, defined contribution plans, and asset management), earnings have become more sensitive to changes in the equity market.
Regulatory Impact
The life Insurance industry is struggling with change in the shape of regulatory reform, which may result in the need to hold higher levels of capital reserves, proposed changes to U.S. generally accepted accounting principles (“GAAP”) for life insurers and potential changes to tax policy. For instance higher marginal tax rates as proposed by Federal tax Legislation could have a positive impact upon the sale of insurance and annuity products.
Substantive changes to existing health care laws and the addition of new health care and related laws in Health Care Reform Legislation could potentially negatively impact some of LNC‟s lines of businesses. Similarly LNC has been impacted by legislations such as Financial Reform
Legislation, Patriot Act, Employee Retirement Income Security Act (“ERISA”) Considerations, Broker-
Dealer, Securities and Savings and Loan Regulation, TARP CPP, Stimulus Legislation
European Debt Crisis
Lincoln has a modest direct exposure to distressed European countries which amounts to 0.1% of its total investments. However the adverse effects of European crisis on financial stability of United States economy, could indirectly weigh down the financial results for LNC.
Competitive Pressures
The insurance industry remains highly competitive .The company's main products--annuities and life insurance--are commodities easily replicated by competitors and subject to customer switching in search
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of lower prices .The increasing competition in the market could have an adverse impact on product pricing, which in turn would put pressure on the company's margins. In addition, a number of the industry‟s products can be relatively identical and subject to intense price competition. This could further cause the deterioration the company‟s financial performance.
Financial Analysis:
Historical
The chart below provides historical financial results for LNC
Lincoln National Corp Historical Financial Summary
($ in millions) 2010 2009 2008 2007
Net Sales
2006
Annuities
Defined Contribution
2,654 2,301
988 926
Total Retirement Solutions 3,642 3,227
Life Insurance 4,590 4,295
Group Protection
Total Insurance Solutions
Other Operations
1,831 1,200
6,421 5,495
344 300
2,438 2,533
932 986
3,370 3,519
4,261 4,189
1,061 1,334
5,322 5,523
532 473
2,060
988
3,048
3,470
1,032
4,502
457
Investment Management
Lincoln UK
Total Revenue
% of Growth
Operating Earnings
% of Sales
EPS Basic
EPS Diluted
10,407
1,037
9,022 9,224
590
370
10,475
564
308
8,879
15.35% -2.19% -11.94% 17.97% 62.17%
942
9.96% 10.44%
3.11 -1.65
3.01 -1.85
828
0.22
0.15
1,372
8.98% 13.10%
4.52
4.4
1,290
14.53%
4.79
4.5
Lincoln has considerably improved revenue generation in 2010 after negative growth in preceding two years. The Insurance solutions-group protection businesses are driving the revenue with a total increase of
52% over 2009 followed by15% increase in Retirement Solutions-Annuities. Life Insurance also showed increase of 6% whereas Defined contribution is down by 6%.The results of 2009-2008 were adversely impacted by the disposal of Lincoln UK operations and Investment Management services along with downturn in overall economy which is reflected in drop of revenue across all lines of businesses. The operating earnings are showing an overall modest positive trend however it is still below 2007 level.
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Ratio Analysis: Historical
The operating margins are constantly dropping over a period of five years, showing a total decrease of
4.59% over last year and 31% over 2006 level. Although the Net profit Margin has improved in 2010 with an increase of 275% which is good sign but the net profit margins are still below the 2007 level.
Return on asset has increased in 2010 with 288% but still below 2007 level. Return on equity has increased in 2010 with 284% still below 2007.Debt/Asset and Debt/ Common Equity is constantly decreased since 2008.Total Investment/Asset and Total Investment/Liabilities are gradually increasing over a period of five years.
2010 2009 2008 2007 2006
Profitability
Operating Margin 9.96% 10.44% 8.98% 13.10% 14.53%
9.42% -5.38% 0.62% 11.60% 14.82% Net Profit Margin
Management Effectiveness
Return on Assets
Return on Equity
0.51%
7.65%
-0.27%
-4.15%
0.03%
0.71%
0.63%
10.37%
0.74%
10.79%
Solvency
Debt/Asset
Debt/Common Equity
Total Investment/Asset
2.79% 2.85% 2.90% 2.41% 1.94%
42.16% 43.16% 59.31% 39.41% 28.34%
43.00% 42.79% 41.28% 37.57% 40.05%
Total Investment/Liabilities
Projections
($ in millions)
46.04% 45.81% 43.40% 40.02% 42.99%
Projection
The chart below provides projected financial results for LNC
Lincoln National Corp Historical Financial Summary
Total Revenues
Consensus
% of Growth
Operating Earnings
% of Sales
2013E
13,247
12,100
9.59%
1,908
14.40%
2012E
12,088
11,840
8.35%
1,722
14.24%
2011E
11,156 10,407
11,230
7.20%
14.09%
2010A
1,572 1,037
Net EPS
Consensus
3.94
4.00
3.55
3.65
3.24
3.94
3.01
Revenue growth is expected to improve over projected period. The rebound will be driven by more stable products such as Defined Contribution and Group Protection vs. longer duration, more capital intensive business lines. Operating margins are projected to improve as company continues to implement its risk management initiatives.
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Dupont Analysis
Dupont analysis:
Profit Margin (Net Income / Revenue)
5-year average 2010 2009 2008 2007 2006
6.22% 9.42% -5.38% 0.62% 11.60% 14.82%
Total Asset Turnover (Revenue/ Assets)
Return on Investment
Equity Multiplier
Return on Equity (ROI*Equity Multiplier)
5.31%
0.33%
16.45
5.08%
5.37%
0.51%
15.15
7.66%
5.08%
-0.27%
17.31
-4.73%
5.65%
0.03%
18.00
0.63%
5.47%
0.63%
15.47
9.82%
The Dupont analysis of Lincoln describes the relationship between the Lincoln‟s profit margin ,asset utilization and leverage to depict operational efficiencies. Lincoln‟s profit margin for year 2010 is above the five year average by 33% and 157% above 2009 .However it is still below 2007 by 23%.When viewed in conjunction with Lincoln‟s asset turnover ,we can see how return on investment stems from their net profit per asst turn to produce 0.51%,return on investment which is 35%up from the last five years average.
4.97%
0.74%
16.32
12.03%
I arrived at Lincoln‟s equity multiplier, a ratio describing the amount of assets available per equity dollar.
This number has lowered over the past 5 years, and is below their 5 year average, an indication that they have reduced their overall leverage. By dividing the return per dollar of assets by the equity multiplier, I calculated the return per dollar of equity at 7.66%, a 157% increase from 2009. I project that their long term Return on Equity will converge on their 5 year average of 5.08
Peer Comparison
LNC MET PFG HIG Industry
Profitability
Operating Margin
Net Profit Margin
Return on Equity
Growth
Management Effectiveness
Return on Assets
14.96%
9.35%
0.51%
7.10%
13.23%
8.87%
0.79%
11.00%
13.14%
8.32%
0.52%
7.85%
6.33%
5.13%
0.29%
4.44%
4.70%
9.40%
Revenue($ in b)
Earnings($ in b)
Market Capitalization ($ in b)
Dividend yield%
10.73
1.61
5.3
1.6
66.62
9.45
32.4
2.4
9.02
1.31
7.4
2.9
22.48
2.10
7.7
2.3
724.60
36.20
3237
3.1
Source: yahoo finance as on Nov27,2011,
Operating profit in the industry tends to vary according to company size and product type. Industry operating profit for fiscal 2010 averaged approximately 4% of revenue. Lincoln‟s profitability is higher than industry and peers whereas the management effectiveness is below the industry. Based on market
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Cap, Revenue and earnings, Lincoln is not a major player in the highly competitive industry. Lincoln‟s profitability is higher than industry and peers whereas the management effectiveness is below the industry.
Valuation Analysis
Valuation Through Comparable
Absolute
Valuation
High Low Median Current #Your
Target
Multiple
A. B. C. D.
P/Forward E 13.7 1.8 10.8
P/S
P/B
2 0.2 1.4
1.8 0.2 1.3
5
0.6
0.4
E. F.
8
1.05
0.97
*Your
Target E,
S, B, etc/Share
3.02
G.
32.02
39.4
Your
Target
Price
(F x G)
H.
24.46
33.62
38.41
Weig hts
Weighted
Price
I
10% 2.44
J
10% 3.36
50% 19.20
P/EBITDA 35.5
1
P/CF 14.2
1.66
2
6.7
9.7
3.11
5
Weighted Price Per share(multiples)
5.02
7.02
3.19
3.02
16.02
21.97
0 0
10% 2.19
27.21
Through analyzing Lincoln‟s historic valuation multiples, it becomes apparent that relative to historic multiples, Lincoln is trading at a significant discount. On each multiple examined, Lincoln trades at a discount to the 10 year median, and significant discount to 10 year highs. Financial theory suggests that competitive forces will tend to drive the ratios of a firm to its historic mean, however for the purpose of valuing LNC; this assumption could lead to misleading valuation. The rate of change for each ratio was analyzed over the last 12 months, 6 months, and 3 months and 30 days. This rate of change data along with high probability of continued uncertainties in current economic environment (e.g. low interest) was used to forecast the target multiples for each ratio In considering weights , P/EBITDA is ignored whereas
50% weight is given to P/B ratio and equal weights are given to rest of the multiples.
Also noteworthy is that Lincoln is trading at significantly lower multiples than the S&P 500 and industry peers. This suggests that the markets are undervaluing Lincoln compared to its peers. While multiples best provide historical context to overall valuation, they support my sum of parts valuations however stands at a discount with respect to DCF analysis.
Current Multiples Lincoln Industry S & P 500
P/Trailing E
P/Forward E
P/B
P/S
P/CF
4.8
4.6
1.8
4.6
4.9
0.69
0.71
0.5
0.8
0.7
0.39
0.38
0.2
0.4
0.6
Page 16 of 20
Valuation –Discount Cash Flow
Appendix A presents my full discounted cash flow analysis with which I arrive at an equity value of $39.27, 112% upside from current level of $18.52 .To generate my cash flow I relied on following assumptions:
A revenue growth of 4%: I assumed that Company will follow the market terminal growth rate of
4%.During 2010, A.M. Best, S&P, Fitch and Moody‟s each revised their outlook for the U.S. life insurance sector to stable. It is assumed that the revenue of Lincoln would grow in line with the market as softer sales will be offset by new product development and increasing sales
The discount rate of 12.5% was assumed. The cyclical sector warrants a higher discount rate. I have used 12.5% discount rate in view of the cyclicality and uncertainty for future cash flows due to decrease of interest rates potential volatile equity market, potential unstable credit markets, effects on future earnings and business model due to the implementation of new accounting requirements in
2012, Continuation of unfavorable non-medical loss ratios in Insurance Solutions – Group Protection segment, attributable primarily to unfavorable disability incidence, which affected main products
(long-term disability, short-term disability and life waiver of premium and continuation of economic challenges.
The Projected revenue growth rate for 2012, 8.3% slows over time. By the terminal year, revenue growth fades to 4% terminal growth rate.
Operating margins are held in line with past results of 11%.
The tax rate of approximately 30%.Reversion to Company‟s mean
I also analyzed DCF‟s sensitivity to changes in discount rate and in terminal growth rate attached as
(Appendix B). Please Note that using a higher discount rate or a slower growth rate, one could arrive very close to the current stock price under my set of assumptions.
Valuation: Sum of Parts Analysis:
For the sum of parts analysis, I divided Lincoln sales by segment. For each segment, I
Identified at least three pure play competitors, and calculated their Price to Book ratios. These Price to
Book ratios were averaged, and then multiplied by Lincoln segment book value to estimate expected segment market capitalization. The sum of the segment market capitalizations indicates the segmentweighted expected market capitalization based on segment competitors P/B ratios. This indicates that on a book value basis, considering a discount of 10% to the market, Lincoln is valued at $ 20.32 , reflecting a
9.89% upside to the current market price of $18.49
Page 17 of 20
Sum of Parts Valuation
Segment :
Annuities
Defined Contribution
Total Retirement Solutions
Life Insurance
Group Protection
Total Insurance Solutions
Total
FY 2011E Price Using
Book Value P/b Multiple Shares P/b Multiple
7720
2345
2756
837
308
308
8.95
2.72
10065
4495
340
4835
14900
3593
3125
236
3362
6955
308
308
308
308
11.67
10.15
0.77
10.91
22.58
Total Company
Discount/Premium
Price / share 20.32
Insurance Solution
Segment
Prudential Financial
Inc
MetlifeInc
P/B
Multiple
P/B
Disc/Prem
0.6
Aflac
Aig
Industry Average
0.52
1.51
0.46
0.77
Discount Multiple 0.7 10%
Valuation Composite of Scenarios
Value per Share
Multiple Analysis
Sum of Parts Analysis
Discounted Cash Flow Analysis
Composite $ per Share
27.21
20.32
39.27
Current Price
Upside
Upside %
Hartford Fin'l Services
Industry Average
Discount Multiple
Retirement Solution
Segment
Principal Financial
Group
Genworth Financial
P/B
Multiple
0.69
Weight
80%
Weighted $
21.76
10% 2.03
10% 3.92
$27.72
$18.52
$9.20
49.67%
0.17
0.33
0.4
0.36
10%
10%
Page 18 of 20
Risks & Considerations
Economic Outlook in United States: LNC performance is highly dependent on performance of economic indicators such as low interest rates, high unemployment, low nominal GDP growth ( below 3.5%), unfavorable housing sector, customer credit delinquencies adverse capital and credit market and impact of Global crisis (Euro zone debt , Middle East instability and
Afghanistan War) on United States Economy.
Regulatory Risks : LNC is subject to rigorous regulation by federal and state government.
Regulation by governmental authorities may increase compliance cost and exposure to litigation
Restricted Geographical Presence : LNC lacks geographical diversification as its businesses are solely concentrated in US. The concentrated operations in single region not only expose LNC to business risks related to US economy but also restricts its access to promising growth opportunities in of emerging and frontier markets
Any downgrade in LNC‟s credit rating and/or financial strength
Strong Public Opinions, De-stability in socio-political environment(Occupy Wall Street)
Conclusion
With a target price of $27.72, Lincoln National Corp is currently recommended as a BUY . The target price represents 49.67% upside from the $18.52 closing price as of November 28, 2011 and a total return
(including dividend yield) of 51%. The BUY rating reflects the strong balance sheet, financial flexibility and effective Risk management underlying the Company. Moreover, share repurchase of $375(m) year to date and increase of 60% in quarterly dividend shows management„s conviction that economy is recovering. Lincoln National Corp also recently appointed three key executives with proven track record in the industry and announced strategic initiatives for retirement and Insurance businesses that may act as a potential catalyst for improvement. Additionally, strategic initiatives coupled with a shift to a diversified product mix, strong distribution channels and technology platforms will contribute to high earnings and revenue generation in years ahead. Finally, Lincoln National Corp offers an attractive total return investment and valuation metrics demonstrate that its shares currently are relatively inexpensive compared the market and based on historical performance.
Page 19 of 20
Appendices
Appendix A
Lincoln Na tiona l Corp
LNC
Ana lyst: Sha zia Sulta na
Da te : 10/17/2011
Ye a r
Re ve nue
% Grow th
Ope ra ting Income
Operating Margin
Inte re st a nd Othe r
Interest % of Sales
Ta x e s
Tax Rate
Ne t Income
% Grow th
Fre e Ca sh Flow
% Growth
NPV of Ca sh Flow s
NPV of te rmina l va lue
Proje cte d Equity Va lue
Fre e Ca sh Flow Yie ld
Curre nt P/E
Projected P/E
Curre nt EV/EBITDA
Projected EV/EBITDA
Te rmina l Discount Ra te =
Te rmina l FCF Grow th =
2014E 2015E 2016E
12.5%
4.0%
2017E 2011E 2012E 2013E 2018E 2019E 2020E 2021E
11,156 12,088
8.3%
13,247
9.6%
13,777
4.0%
14,259
3.5%
14,758
3.5%
15,312
3.8%
15,847
3.5%
16,434
3.7%
17,091
4.0%
17,775
4.0%
1,572
14.1%
1,722
14.2%
1,908
14.4%
1,791
13.0%
1,854
13.0%
1,919
13.0%
1,991
13.0%
2,060
13.0%
2,136
13.0%
2,222
13.0%
2,311
13.0%
(223)
-2.0%
(297)
-22.0%
1,572
1,572
(242)
-2.0%
(326)
-22.0%
(265)
-2.0%
(361)
-22.0%
(276)
-2.0%
(455)
-30.0%
(285)
-2.0%
(471)
-30.0%
(295)
-2.0%
(487)
-30.0%
(306)
-2.0%
(505)
-30.0%
(317)
-2.0%
(523)
-30.0%
(329)
-2.0%
(542)
-30.0%
(342)
-2.0%
(355)
-2.0%
(564)
-30.0%
(587)
-30.0%
1,154
-26.6%
1,154
-26.6%
1,281
11.0%
1,281
11.0%
1,061
-17.2%
1,061
-17.2%
1,098
3.5%
1,098
3.5%
1,136
3.5%
1,136
3.5%
1,179
3.8%
1,179
3.8%
1,220
3.5%
1,220
3.5%
1,265
3.7%
1,265
3.7%
1,316
4.0%
1,316
4.0%
1,369
4.0%
1,369
4.0%
7,252
5,157
12,409
26.86%
3.7
7.9
7.5
11.7
58%
42%
100%
5.1
10.8
6.9
10.7
4.6
9.7
6.2
9.6
316
Te rmina l Va lue
Fre e Ca sh Yie ld
Te rmina l P/E
Te rmina l EV/EBITDA
16,746
8.17%
12.2
8.1
Sha re s Outsta nding
Curre nt Price
Implie d e quity va lue /sha re
Upside /(Dow nside ) to DCF
De bt
Ca sh
Ca sh/sha re
Tota l Asse ts
De bt/Asse ts
W orking Ca pita l % of Grow th
112.0%
8,892
2,912
9.22
201,554
4.4%
20%
Appendix B
Sensitivity Analysis
Sensitivity Analysis
Terminal Discount
Rate
10.00%
10.50%
11.00%
11.50%
12.50%
13.00%
Terminal FCF Growth
1.00% 2.00% 3.00% 4.00% 5.00% 6.00%
44.35
42.00
46.90
44.19
50.18
46.95
54.55
50.57
60.67
55.50
69.86
62.63
39.89
37.98
34.66
41.77
39.61
35.91
44.13
41.63
37.41
47.15 51.18 56.82
44.18 47.51 52.06
39.27 41.62 44.70
33.21 34.30 35.61 37.22 39.22 41.79
Appendix C
Sources:
IBSI World Industry Report-Life Insurance & Annuities in U.S July 2011
Form 10-k,10-Q Lincoln National Corp
Yahoo Finance http://finance.yahoo.com/
S&P report U.S. Life Insurers Maintain a Stable Outlook, Oct 2011
Hoover‟s Report
Thomson Reuters Baseline
Bloomberg-Equity Research –LNC-Wells Fargo /Credit Suisse/JPM
Page 20 of 20
