ROOT - Root Improves Metrics As Industry Progresses To Normal

2023-12-11 16:12:05 ET

Summary

• Root, Inc. provides personal insurance solutions in the U.S. through a mobile-first approach.
• The company has undertaken cost reduction initiatives, including layoffs and reduced marketing spend, to address heavy operating losses.
• While operating losses have been reduced, they remain high, and the company's outlook may be impacted by a potential economic slowdown.
• I remain Neutral [Hold] on Root, Inc. for the near term.

A Quick Take On Root

Root, Inc. ( ROOT ) provides personal insurance solutions in the United States via a mobile-first approach.

I previously wrote about Root with a Hold outlook due to continued heavy operating losses.

Management has undertaken major cost reduction initiatives, including layoffs and sharply reduced marketing spend.

While operating losses have been reduced, they remain high as we may be entering a period of slower economic activity ahead.

For now, I reiterate my previous Neutral [Hold] outlook on Root, Inc. pending further data on its cost reduction initiatives and new pricing models.

Root Overview And Market

Ohio-based Root provides automobile insurance using car data to adjust car insurance pricing based on the driver's personal driving habits.

The firm is led by co-founder and CEO Alexander Timm, who was previously in various management roles at Nationwide Mutual Insurance Company.

Root says it is a

"full-stack insurance carrier...[that owns] nearly every aspect of policy design, origination, underwriting, claims and back-end processing, which enables us to iterate constantly."

The company seeks a large percentage of its customers direct [DTC] via online digital marketing through Facebook and Google.

Management has said that over time, more of its business "will naturally mature as renewal premiums outweigh new premiums, driving profitability."

According to a 2020 market research report by Allied Market Research, the global auto insurance market was an estimated $739 billion in 2019 and is expected to reach more than $1 trillion by 2027.

This represents a forecast CAGR (Compound Annual Growth Rate) of 8.5% from 2020 to 2027.

The primary reasons for this expected growth are a growing number of road accidents in many countries as well as mandated insurance coverage in more regions, and the implementation of stringent government regulations.

Emerging economies are expected to see an increase in discretionary income, producing growing demand for motor vehicles and their attendant insurance coverage requirements.

The Asia Pacific region is forecasted to produce the highest growth rate through 2027 as it increases its adoption of mobile telematics technologies.

Root faces competition from traditional automobile insurers that may adjust their go-to-market and technology offerings to cater to those drivers who wish to include their telematics information in their policy calculations.

Root’s Recent Financial Trends

Total revenue by quarter (blue columns) has increased in the most recent quarter due to higher written premiums; Operating income by quarter (red line) has remained heavily negative, although recent progress toward breakeven has faltered:

Gross profit margin by quarter (green line) has trended higher as a result of improved pricing and lower loss ratios; Selling and G&A expenses as a percentage of total revenue by quarter (amber line) have trended lower due to previous cost reductions and more favorable marketing cost reductions, a positive signal indicating greater efficiency at generating incremental revenue:

Earnings per share (Diluted) have trended higher but remain heavily negative:

(All data in the above charts is GAAP.)

In the past 12 months, ROOT’s stock price has risen 83.75% vs. that of Lemonade, Inc.’s ( LMND ) gain of only 5.4%. This was largely due to a takeover rumor, which the company denied was not "actionable" or in the best interests of the shareholders:

For balance sheet results, the firm ended the quarter with $635.3 million in cash and equivalents and $298.3 million in long-term debt.

Over the trailing twelve months, free cash used was ($126.6 million), during which capital expenditures were $0.2 million. The company paid no stock-based compensation in the last four quarters.

Valuation And Other Metrics For Root

Below is a table of relevant capitalization and valuation figures for the company:

(Source - Seeking Alpha.)

As a reference, a relevant partial public comparable would be Lemonade:

(Source - Seeking Alpha.)

Commentary On Root

In its last earnings call (Source - Seeking Alpha ), covering Q3 2023’s results, management’s prepared remarks highlighted continued growth in new premiums written and its direct marketing channel.

The firm has been able to leverage positive marketing conditions with its automated marketing tactics.

The question is whether those results will be durable or temporary.

Leadership said it had hit its target loss ratio goals and reduced its fixed expense cost structure.

During the quarter, the company continued to scale its newest pricing model and launch a new telematics model that it believes will improve its predictive capability by 12%.

Analysts questioned the leadership about payback periods, loss ratios and its direct customers vs. embedded partner customers.

Management said it is seeing a big improvement in its payback periods due to lower loss ratios and, to a lesser extent, lower customer acquisition costs.

As for the durability of lower loss ratios, the management thinks the industry is back to a "normal trend environment" and is pricing accordingly, leading to more consistent loss ratio performance.

Its DTC customers tend to be better drivers, younger males in their mid-30s, while its embedded partner clients depend on the partner and are more diverse across its partnerships.

For the quarter’s results, total revenue for Q3 2023 rose by 56.4% year-over-year.

Selling and G&A expenses as a percentage of revenue dropped by an impressive 22.6% YoY, and operating losses were reduced by 43.8%.

The company's financial position is reasonably strong, with ample liquidity, some long-term debt but a material amount of free cash used in the last four quarters.

Looking ahead, 2023 top line revenue growth is expected to be 24.1% per analyst consensus.

If achieved, this would represent a return to revenue growth rate versus 2022’s decline of 10% over 2021.

A potential upside catalyst to the stock could include improved revenue and underwriting results from its newly launched pricing models, as well as a continued reduction in inflation resulting in lower loss ratios.

However, the company still has significant work ahead of it to reduce operating losses, as we may be heading into a further economic slowdown.

Leading economic indicators are all pointing to slower growth and lower employment conditions in the months just ahead.

My near-term outlook on ROOT is, therefore, Neutral [Hold] at around $10.50 per share.

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