Operational Optimization Will Support Future Profitability Despite Earnings Challenges

Key Takeaways

• Strategic operational optimization and technology enhancements are expected to drive improved net margins and profitable growth.
  
• Focus shifts in annuities and Group Protection aim to sustain revenue growth with higher margins and risk-adjusted returns.
  
• Elevated mortality in Life Insurance and lower fixed annuity sales could impact earnings, while reliance on macroeconomic conditions poses profitability risks.

Catalysts

Through its subsidiaries, operates multiple insurance and retirement businesses in the United States.

• Lincoln National has been strengthening its capital foundation, notably achieving an RBC ratio of over 430%, thus providing added financial flexibility to support future growth and improve earnings.
  
• The company has strategically focused on optimizing its operations to reduce expenses and enhance technologies, which is expected to improve net margins and drive profitable growth over time.
  
• The launch of a Bermuda-based reinsurance subsidiary is aimed at supporting financial objectives and increasing free cash flow, enhancing earnings in the long term through optimized reinsurance solutions.
  
• Strategic shifts in the annuities business towards a more diversified product mix, emphasizing spread-based products, are expected to sustain revenue growth while achieving higher risk-adjusted returns.
  
• Investments in the Group Protection business, alongside targeted pricing strategies and operational enhancements, should drive higher margin contributions, positively impacting overall earnings growth and profitability.

Lincoln National Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Lincoln National's revenue will grow by 4.5% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 17.7% today to 7.6% in 3 years time.
• Analysts expect earnings to reach $1.6 billion (and earnings per share of $9.15) by about March 2028, down from $3.2 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 5.4x on those 2028 earnings, up from 1.9x today. This future PE is lower than the current PE for the US Insurance industry at 13.2x.
• Analysts expect the number of shares outstanding to grow by 0.22% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.79%, as per the Simply Wall St company report.

Lincoln National Future Earnings Per Share Growth

Risks

• Elevated mortality driven by large claims in the Life Insurance segment led to a quarterly operating loss, indicating potential volatility and impact on future earnings.
  
• Fixed annuity sales were lower compared to previous record levels, partly due to industry-wide declines, which could affect revenue growth and the profitability of spread-based products.
  
• The reliance on favorable macroeconomic conditions, particularly in the Group Protection segment, poses a risk; any unfavorable economic changes could impact margins and profitability.
  
• Despite efforts to optimize expenses, the high level of planned investments and expense reductions may not fully materialize as anticipated, potentially affecting net margins.
  
• The strategic use of reinsurance and capital optimization through the new Bermuda subsidiary involves execution risks, which, if not effectively managed, could impact free cash flow and capital efficiency.

Valuation

• The analysts have a consensus price target of $39.364 for Lincoln National 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 $50.0, and the most bearish reporting a price target of just $32.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $20.5 billion, earnings will come to $1.6 billion, and it would be trading on a PE ratio of 5.4x, assuming you use a discount rate of 7.8%.
  
• Given the current share price of $35.6, the analyst price target of $39.36 is 9.6% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
  
• 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.