LNC - Lincoln National: High Yield Weak Flows Amid Shifting Market Interest Rates

2023-11-16 13:10:42 ET

Summary

• Bond traders no longer expect rate hikes in 2024, instead predicting four quarter-point cuts in the next 13 months.
• Lincoln National Corporation is seen as attractively valued but with elevated risk in the Financials sector.
• LNC's earnings, valuation, and dividend yield forecasts suggest potential for improvement, but caution is advised due to technical factors.
• I outline key price levels to watch heading into 2024.

Bond traders have taken rate hikes off the table for 2024. The market now sees four total quarter-point cuts over the coming 13 months. Treasury yields have also inflected for now, along with some bull steepening in the curve. The rate on the benchmark 10-year note was near 5% at the cycle high but is now half a percentage point lower following soft economic data lately. With the Fed now seen as being done tightening through its policy target rate, is it time to scoop up high-duration plays and stocks crushed by the intense yield-curve inversion? Perhaps, but valuations and price action must be considered when reallocating into 2024.

I have a hold rating on Lincoln National Corporation (LNC). I see this beaten-down Financials company as attractively valued but with elevated risk. The technicals, meanwhile, are less than sanguine.

A Steeper Yield Curve Should Help Rate-Sensitive Financials

According to Bank of America Global Research, Lincoln National ((LNC)) is a diversified life insurer offering annuities, individual life insurance, group benefits, and retirement products and services. LNC's products are distributed through financial planners, wirehouses, banks, and managing general agents.

The Pennsylvania-based $4.0 billion market cap Life and Health Insurance company stock within the Financials sector trades at a low 4.4 forward non-GAAP price-to-earnings ratio and pays a high 7.6% forward dividend yield. Ahead of earnings not due out until February next year, shares trade with a moderate 36% implied volatility percentage, and short interest on the stock is material, though not extreme, at 3.0% as of November 15, 2023.

Earlier this month, Lincoln reported third-quarter earnings per share of $4.82, which was a large $2.61 beat, though revenue was down 12.5% compared to year-ago levels, missing expectations. Ex notable nonrecurring items, EPS came in at $1.48 on a non-GAAP basis. The firm recorded a large $144 million charge due to changes in its annual reserve assumption related to its Life business.

There was an additional unusual charge of $48 million amid net outflows from its Annuities and Retirement lines. On the plus side, a positive ruling from the Indiana Department of Insurance and from the Bermuda Monetary Authority on its Fortitude Re transaction, which is now expected to close this month, is seen as bullish. BofA notes that the transaction could contribute to an additional $100 million in annual free cash flow.

Finally, a turn lower interest rates would benefit Lincoln’s capital-intensive businesses. Normally, insurance companies benefit from rising yields, but unrealized losses on parts of their balance sheet due to both a higher yield curve and its inversion have been problematic - something Harrison Schwartz astutely noted earlier this year.

On valuation , analysts at BofA see earnings rising toward $7 in FY 2024 after volatile stretches in both GAAP and non-GAAP EPS over recent quarters. The consensus outlook, per Seeking Alpha, currently calls for $5.41 of FY 2023 operating EPS and $7.24 of out-year non-GAAP EPS. Dividends, meanwhile, are expected to hold at $1.80 over the coming quarters. Shares trade at exceptionally-low earnings multiples, but that is on par with Lincoln National’s history.

Lincoln National: Earnings, Valuation, Dividend Yield Forecasts

If we assume next - 12-month EPS of $7 and apply the stock’s 5-year average forward non-GAAP P/E, then shares should be near $42. Of course, with much higher interest rates today and the troubled asset-liability balance sheet situation, we must significantly discount the P/E.

What’s more, LNC trades at a somewhat high 1.82 trailing price-to-book ratio – its historical P/B is closer to 1.1. The high capital intensity of the firm’s business lines and products is a key risk, so taking a mix of a discounted P/E and incorporating its P/B is prudent. A 4x earnings multiple would yield a stock price near $28, albeit with considerable risk.

LNC: Low Valuation Metrics, But A High P/B

Looking ahead, corporate event data provided by Wall Street Horizon show an unconfirmed Q4 2023 earnings date of Wednesday, February 7 AMC. Before that, shares trade ex a $0.45 dividend on Tuesday, January 9. No other volatility catalysts are seen on the calendar.

Corporate Event Risk Calendar

The Technical Take

LNC is among the worst-performing Financials-sector companies in the last two years. The stock is down more than 65% on a price-only basis from its peak in November 2021. Notice in the graph below that shares may have found a floor, however. I see support around the $21-$23 area – that was the range high from its Q1 to Q2 zone and where LNC pulled back to during its August through October decline. With a falling 200-day moving average and a series of lower highs over recent quarters, the bears appear firmly in control.

Also, take a look at the RSI momentum indicator at the top of the graph. There was some bullish divergence that took place at the multi-year low earlier this year, but the bears regained control on a rally attempt through the 200dma. I would like to see LNC move above that long-term trend indicator line to help support the thesis that a bearish to bullish reversal is taking shape. Moreover, a climb above the $28 to $29 zone would lend further support to that outlook. For now, though, the onus is on the bulls to change the trend.

LNC: $20 Support, $29 Resistance, Watch the 200DMA

The Bottom Line

I have a hold rating on LNC. The valuation is intriguing given the sharp stock price downtrend, but technical factors warrant caution right now.

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