Torchmark Corporation (TMK, Financial)’s sustainable business model hit a bump in the road last year, when its health care subsidiary Liberty National Life reported a high agent turnover, causing a drop in sales. However, in an effort to improve agent retention, management reacted quickly, introducing new training, recruiting and sales processes, in addition to adding new managerial positions, so as to produce more qualified agents. Although it will take time until the situation is reversed, the company’s strategy has already shown results, increasing its agent count by 8% during fourth quarter fiscal 2013, and thereby boosting health sales by 2%. Furthermore, while life sales declined by 5%, a consequence of a 3% decline in agent count at the American Income Agency, the firm’s direct response channel was successful in offsetting these results, generating an 8% increase year over year in new sales.
A Niche Target Group Can Go a Long Way
In a mature market that is overruled by insurance products, it can be difficult to sustain a long-term competitive advantage. But Torchmark’s trademark position as a low-cost health and life insurance provider has allowed it to target niche demographic groups that are often overlooked by larger insurers. As such, the company provides union members, senior citizens, and middle income families in the southern states with whole life and term life insurance (70% of revenue), as well as health insurance products, which include Medicare supplement policies, Medicare Part D prescription drug insurance, and limited-benefit plans. While the insurer is set on expanding its agent network in several other states in the Southeast and Southwest, its focus will remain on underserved demographic groups and its primary product lines.
Furthermore, Torchmark should continue to benefit from its direct response channel, which enables the company to market insurance at low distribution and acquisition costs, thereby earning it a competitive advantage. This company’s unique market approach in selling lower-margin group policies has earned it a narrow moat rating, thus recently attracting investment gurus like Steven Cohen (Trades, Portfolio) and John Keeley (Trades, Portfolio) as shareholders. Nevertheless, the insurer remains subject to state regulations, exposing it to regular supervision in its operating states. Also, as the company’s main target group is the middle class, it could suffer greater damage in case of an economic downturn. However, the firm’s low-cost operating model has allowed it to sustain returns on equity of 13.99% for 2013, compared to the industry average of 9.25%, which investors should find appealing.
Focus on Core Products to Result in Growth
While the company’s distribution channel is easily scalable and could be applied in other markets, management has made it clear that it will continue to focus on its core products and niche target groups in order to sustain growth levels and offset its agent turnover. Therefore, life insurance premium revenue is expected to increase at a low single-digit rate, whereas health insurance will pick up throughout fiscal 2014. Thus, 2013’s 14% revenue growth will likely slow down, while still boasting a 3% CAGR for the next five years.
Nonetheless, earnings per share for fourth quarter fiscal 2013 closed at $5.68, and should continue to increase looking forward, given the 10.2% growth rate. The current net profit margin of 14.01% will also continue to grow, averaging 16% until 2018, and returns on equity should average pre-crisis levels of 15% for the following years, making me optimistic about future profitability. Furthermore, with the stock’s trading price at 13.8x trailing earnings, barely below the industry average, I believe this is an accurate time for investors to consider a share purchase.
Disclosure: Patricio Kehoe holds no position in any stocks mentioned.
