LNC - Lincoln National: The Commons Or Preferreds? One Might Be Undervalued

2023-07-17 14:23:22 ET

Summary

• Lincoln National is paying its common shareholders a 6.8% dividend yield.
• This is on the back of common shares that have lost 42% of their value over the last year on Life Insurance weakness.
• The preferreds are trading at a small premium to par value but come with a yield that is 150 basis points more than the commons.

The last year has been terrible for Lincoln National ( LNC ) stock, with the commons down 42% to track down a broader market that's been moved lower by ten consecutive interest rate hikes until the June FOMC meeting. The dividend has been consolatory, with Lincoln National last declaring a quarterly cash dividend of $0.45 per share , in line with its prior payout and for a 6.8% annualized forward dividend yield. This yield has pulled back from a decade-high reached in May but still sits quite high against quarterly payouts that have been raised at a 7.06% compound annual growth rate over the last five years.

Lincoln Financial provides a range of financial products from retirement, wealth protection, and insurance. This brought in revenue of $3.81 billion , a 19.3% decrease over the year-ago quarter and a huge miss by $780 million on consensus estimates. The decline was led by Life Insurance where sales were down 16%. This decline was set against sales of $3.2 billion for the Annuities business, which had a year-over-year growth rate of 17%.

Operating Results Experience Some Weakness

The company also recorded a miss on adjusted operating income available to common stockholders which, at $1.52 per share, underperformed consensus estimates by $0.01 per share. Overall, the quarter was one of continued headwinds from lower prepayment income, higher expenses, and the current weakness of Life Insurance, which the company expects to strengthen in 2024. The unit reported an operating loss of around $13 million, down from a profit of $23 million in the year-ago comp. Critically, this was a segment that generated $500 million to $600 million in earnings annually prior to the pandemic, with its decline broadly being led by a number of factors including COVID.

During its first quarter earnings calls , the company indicated that they're seeing declining mortality headwinds as the pandemic turns endemic, but that mortality rates remain elevated versus their pre-pandemic level. This comes with Lincoln National swapping hands at a marginal discount to its book value. The call inferred a continued level of uncertainty around this business unit and set the tone that current macroeconomic headwinds will continue to weigh on business operations.

The 8.3% Yield Series D Preferred Shares

Lincoln National's 9.0% Depositary Shares ( LNC.PD ) each represent a 1/1000 interest in a share of its non-cumulative Series D preferred stock. They pay out a fixed $2.25 annual coupon in quarterly installments for an 8.3% yield on cost. This is actually lower by the security's headline yield of 9% with the Series D currently swapping hands for around $27 per share, around $2 more than their $25 par value. Crucially, this 8% premium to par is a result of the high headline yield set against a low-risk financial services firm with a long operating history.

However, I'd understand apprehension to buy them against a broad preferred share universe highly characterized by double-digit discounts as a rising Fed funds rate forced prices down due to the positive duration effect. Preferred securities are essentially half bond and half equity, and their value tends to fall in response to any interest rate increases. The Series D preferreds are down from their all-time highs of $30.15, but the continued premium to par likely highlights the extent of market confidence in Lincoln National. These only started trading in November last year following the IPO of 20,000,000 depositary shares for $500 million in gross proceeds. Further, whilst they come up for redemption on December 1, 2027, they're also perpetual, so there is no obligation on Lincoln National to fully redeem at par at its call date.

Whether or not you go with the commons or preferreds will depend on your appetite for risk. This conundrum is made easier with the preferreds trading above par versus commons that are trading at a marginal discount to book. The commons are also swapping hands at a 3.78x forward non-GAAP price-to-earnings ratio. This is around 58% lower than its peer group median and around 40% lower than Lincoln National's own five-year average. The preferreds have held up better year-to-date, down around 0.77% on a total return basis versus a loss of 10% for the commons.

On an enterprise value to trailing 12-month sales multiple, the company is swapping hands for 0.51x, around 40% lower than its 5-year average and markedly lower than its peer group median. Hence, even with the preferreds offering a yield that's 150 basis points more than the commons, the relative undervaluation of this common equity implies a greater upside potential than the preferreds whose current premium presents a small downside risk. Bears, who form the 4.8% short interest, would be right to flag the double-digit revenue decline as a core reason to avoid, but the selloff might have gone too far. This is a hold.

For further details see: