We are reiterating our Neutral recommendation on the shares of Torchmark Corp. (TMK) following the release of fourth quarter 2010 earnings. We believe that its life and health business will experience a restricted top-line growth. However, given ample free cash flow, we expect bottom-line earnings to be aided by significant share buyback.
American Income, which is Torchmark’s most profitable distribution system contributing roughly 34% of its 2010 underwriting margin, has grown consistently over the last 10 years. In the last three years, the number of producing agents at the unit has surged 54% from 2,545 to 3,912, and net life sales have swelled 50% from $92 million to $138 million. However, the reported quarter witnessed a 7% decline in life sales after having increased every quarter since the second quarter of 2006. Management is trying to combat the sales decline by renewing growth in producing agents and sales at the agency. These initiatives would expectedly begin to see a turnaround in sales in the first quarter of 2011. Management has, however, lowered the guidance for 2011 new sales growth to the mid-single-digit range from the 10–15% range projected earlier. Given its niche in less competitive organized labor market, we believe the unit can recapture its lost sales.
Life sales at Liberty National declined 19% to $45 million in 2010, after having increased 1% a year earlier. This agency had 2,001 producing agents at December 31, 2010 compared with 2,471 a year earlier, marking the 19% drop. The agent count at Liberty had also plunged 51% in 2009 from 5,020 partly due to the closing of several offices with low production. Furthermore, agent compensation issues that cropped up in 2009 impacted agent counts negatively. But, much effort was given during 2010 to improve the underwriting margins at Liberty National. In addition to improving persistency, significant rate increases were implemented in the life insurance portfolio during the reported quarter. While these changes were necessary, they did adversely affect new sales. The negative impact of these changes is gradually getting mitigated and management fully expects double-digit growth (a little in excess of 10%) in its life sales at Liberty National in 2011.
Delphi’s direct response operation at Globe Life has also grown consistently. Life premiums over the last 10 years have increased from $268 million to $567 million at a 7.8% CAGR, while life underwriting margin rose from $71 million to $145 million at a 7.4% CAGR. Direct response operation continues to perform consistently and should experience better sales if the economy improves. The company anticipates 8–10% growth in life sales at its direct response channel.
However, earnings from Torchmark’s health operations have experienced intense competition in recent periods, resulting in significant decline in agent counts, which in turn has caused lower sales of new health products. Health underwriting margins were flat at $170 million in 2010 after having declined $24 million or 12% in 2009. Health premium inched down 3% in 2010 after having dropped 10% in 2009. Agent turnover has increased as lower premium and lower margin products offered by competitors have provided agents with products that are easier to sell. Turnover has also increased due to the company’s decision to de-emphasize the marketing of certain limited-benefit products. Sales of these de-emphasized products were discontinued altogether after September 2010.
Medicare Supplement remains the largest contributor to total health premium. But increased competition has also dampened sales of this product in recent years, resulting in premium declines in each successive year. The Medicare Part D premium hiked 14% in 2010, after having increased 5% in 2009. However, as most of the country’s Part D enrollees selected a plan provider in 2006, no significant growth is expected in Part D business going forward. Nevertheless, management believes that after several years of decline, health sales have hit the bottom; therefore, it anticipates single-digit growth in new health sales for 2011.
Finally, with respect to returning capital to shareholders, Torchmark can be touted as a shareholder-friendly company as it has been actively increasing shareholders’ wealth through an ongoing buyback program since 1986. In August 2010, the company increased its quarterly dividend by 7%. Its dividend yield of 1.18% supersedes the industry average of 1.08%. Although it had temporarily suspended its buyback activity since the first quarter of 2009 because of the economic slump, it reactivated the program in the first quarter of 2010. Over the last five years, the company has repurchased approximately 15% of its stock. It has also been consistent in free cash flow generation. With $655 million of 2011 free cash flow expected at the parent company, we anticipate a continual buy back activity in 2011. Management has guided $600 million to $650 million in share repurchase for the year 2011.
Overall, we hold a positive stance towards the stock of Torchmark over the long term given its niche in the middle income markets, which is a huge under penetrated opportunity in the United States and Canada.
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