Expansive Costs Will Undermine Future Profitability In US Insurance

Key Takeaways

• Strategic investments in marketing and data science might boost future growth but will likely increase short-term expenses and pressure net margins.
  
• Reducing insurance rates in select states may drive customer growth but risks impacting net margins if policy volumes don't rise.
  
• Root's strategic cost reductions, channel expansion, and enhanced technology drive profitability, revenue growth, and sustained long-term financial success.

Catalysts

Provides insurance products and services in the United States.

• Root plans to reduce insurance rates in select states due to a consistently strong gross loss ratio performance. While this could enhance customer renewal and acquisition rates, it might also put pressure on premiums and potentially impact net margins adversely if not balanced by increased policy volumes.
  
• The company is investing in expanding direct marketing channels, including mid
• to upper-funnel strategies. While this presents growth potential, it involves costs that may impact operating expenses and net margins in the short term before potentially boosting long-term revenue and earnings.
  
• Root is focusing on expanding and diversifying its distribution through partnerships and state expansions, which could increase revenue. However, the success of these partnerships is uncertain and may temporarily increase operating costs, thereby pressuring net margins.
  
• Root's strategic shift to include more up-funnel ad spending, while maintaining strict performance criteria, could enhance brand visibility and customer acquisition in the long term. However, these changes might result in increased marketing expenses, which could impact net margins and profitability in the near term.
  
• The company plans continued investment in data science, personnel, and infrastructure, aiming for long-term growth. While this could enhance future earnings through more efficient operations and better customer insights, such investments may also increase operating expenses and temporarily affect net margins.

Root Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Root's revenue will grow by 10.4% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 4.2% today to 4.0% in 3 years time.
• Analysts expect earnings to reach $68.7 million (and earnings per share of $4.08) by about July 2028, up from $52.9 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $88.1 million in earnings, and the most bearish expecting $28 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 40.7x on those 2028 earnings, up from 36.6x today. This future PE is greater than the current PE for the US Insurance industry at 14.4x.
• Analysts expect the number of shares outstanding to grow by 2.44% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.4%, as per the Simply Wall St company report.

Root Future Earnings Per Share Growth

Risks

• Root Inc. achieved its first full year of net income profitability in 2024, indicating a positive trend in financial performance that could enhance earnings in the future.
  
• The company reduced its run rate interest expense by more than 50% and significantly lowered reinsurance costs, potentially improving net margins going forward.
  
• Root's policies in force grew by 21% year-over-year, suggesting effective customer acquisition and retention strategies that could positively impact revenue growth.
  
• The successful expansion into new distribution channels, such as partnerships and direct channels, and national expansion efforts are expected to provide new revenue streams and sustain long-term growth trajectory.
  
• Continued improvement in Root's technology and data-driven underwriting practices allowed the company to maintain a best-in-class loss ratio, supporting stable profitability and reduced claim costs, which benefit net earnings.

Valuation

• The analysts have a consensus price target of $145.0 for Root based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $172.0, and the most bearish reporting a price target of just $118.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $1.7 billion, earnings will come to $68.7 million, and it would be trading on a PE ratio of 40.7x, assuming you use a discount rate of 6.4%.
• Given the current share price of $126.1, the analyst price target of $145.0 is 13.0% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.