March 12, 2015 Torchmark Corp. Current Recommendation NEUTRAL Prior Recommendation Underperform Date of Last Change 07/20/2006 Current Price (03/11/15) $53.41 Target Price $56.00 SUMMARY DATA (TMK-NYSE) SUMMARY Torchmark Corp. fourth quarter s earnings came in line with the Zacks Consensus Estimate but was higher year over year. We expect the company s niche market focus, steady capital deployment and strong operating fundamentals to help its performance in the upcoming quarters. Among the company s distribution channels, American Income Agency and Direct Response are performing well. Liberty National, however, remains soft despite the restructuring efforts undertaken for its turnaround. The company estimates life and health sales growth in each distribution channel. We are also optimistic about the company s acquisition of Family Heritage Life, which is accretive to earnings. A strong capital position and good capital management make Torchmark an investor favorite. However, in 2015, it expects administrative expenses to increase about 6% to 7% (about 5.8% premium) due to higher pension costs and further investments in IT systems. Nonetheless, earnings are expected to grow 7% in 2015. 52-Week High $55.68 52-Week Low $50.07 One-Year Return (%) 2.45 Beta 1.16 Average Daily Volume (sh) 638,820 Shares Outstanding (mil) 127 Market Capitalization ($mil) $6,783 Short Interest Ratio (days) 3.51 Institutional Ownership (%) 75 Insider Ownership (%) 4 Annual Cash Dividend $0.51 Dividend Yield (%) 0.95 5-Yr. Historical Growth Rates Sales (%) 4.0 Earnings Per Share (%) 10.3 Dividend (%) 14.6 using TTM EPS 13.3 using 2015 Estimate 12.4 using 2016 Estimate 11.3 Risk Level * Low, Type of Stock Large-Value Industry Ins-Life Zacks Industry Rank * 215 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 875 A 877 A 864 A 931 A 3,547 A 2014 1,007 A 983 A 891 A 996 A 3,964 A 2015 1,006 E 1,002 E 992 E 965 E 3,965 E 2016 4,030 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $1.39 A $1.42 A $1.43 A $1.46 A $5.70 A 2014 $1.01 A $1.02 A $0.99 A $1.00 A $4.03 A 2015 $1.05 E $1.07 E $1.09 E $1.11 E $4.32 E 2016 $4.72 E Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page Projected EPS Growth - Next 5 Years % 8 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 111 North Canal Street, Chicago IL 60606
OVERVIEW Formed in 1970, and based in Birmingham, AL, Torchmark Corp. provides annuities, whole and term life insurance, accidental death insurance, health insurance, Medicare supplements, and long-term healthcare policies. Torchmark s main subsidiaries include Liberty National Life, American Income Life Insurance, United Investors Life Insurance, United American Insurance, as well as Globe Life and Accident Insurance. The company classifies its operations into four insurance segments and an investment segment. Life (accounted for 62% of total premium revenue in 2014): This segment provides life insurance primarily through its American Income (labor union affiliates), direct response (targeted at juvenile and senior life coverage for lower middle-income families), Liberty National (lower middle-income families) and Military channels. It provides either whole or term life insurance, where whole life insurance offers an investment (bonds, stocks) option in the plan for a higher premium and term life insurance offers life coverage only in exchange for a lower premium. Health (28%): This segment provides supplemental health policies with guaranteed renewable coverage, including Medicare supplement, cancer, accident, long-term care, as well as limited hospital and surgical protection. Health Medicare Part D (6%): This segment is distributed by Direct Response and the United American agencies. It offers Medicare Part D prescription drug plan and Medicare Supplements. Both are sold primarily to people over 65 years. REASONS TO BUY Continued Superior Performance at American Income Torchmark s most important distribution channel American Income Exclusive Agency was the largest contributor to life premium and net sales in 2014. Life premium for this agency rose 7%, after rising 8% in 2013. Net sales rose 13% in 2014, after declining 4% in 2013 and rising 12% in 2012. Continued improvement in product sales is largely dependent on agent count increase. The American Income agent count increased 21% in 2014, 2% in 2013 and 18% in 2012. Management s primary objective is to grow middle management in the agency to ensure sustainable growth. This is being achieved through an increased emphasis on agent training programs and financial incentives that appropriately reward agents at all levels for helping in development and training personnel. The company has also started providing more homeoffice and webinar training programs. These programs are designed to provide each agent, from new recruits to top level managers, with coaching and instruction specifically designed for each individual s level of experience and responsibility. We believe that these initiatives will continue to promote the field and drive increases in agent retention and sales activity, consequently driving premium increase. The company expects life sales growth in 2015 within a range of 6% to 10%. Consistent Operations at Global Life Global Life Globe Life is largely benefited by low competition as it operates in a relatively non-competitive market selling basic life insurance products to middle and lower middle-income households. Globe Life also enjoys some competitive advantages like an experienced group of people, cost control etc., which gives it an edge over its competitors. The direct response operation at Globe Life has also consistently grown with Life premiums achieving a CAGR of 9.0% and underwriting margins achieving a CAGR of 7.0%, since 1995. While Direct response operations continues to grow its traditional direct mail and insert media distribution, management is also trying to develop new distribution platforms like the Internet and social networking sites. The company expects life sales growth for full-year 2015 in the range of 4% Equity Research TMK Page 2
to 8% driven by higher contribution from the operation given improving response rates and positive results on lower priced adult insurance offerings and electronic media. Acquisition of Family Heritage We are positive on Torchmark s acquisition of U.S. based Family Heritage Life Insurance Company in 2012. The acquisition was immediately accretive to Torchmark s earnings. The acquisition is deemed as the best fit for Torchmark, since it was aiming to grow in the supplemental health insurance line of business, with a return-of-premium feature, which provides a higher margin. The company s health sales from Family Heritage for full-year 2015 are expected grow in the range of 4% to 10%. Restructuring Yielding Positive Results Torchmark s restructuring efforts aimed at divesting its non-core businesses have strengthened its capital and are, at the same time, enabling it to focus on its core operations. In Sep 2010, Torchmark had sold off its unit United Investors Life to Protective Life. The divestiture resulted in axing fixed and variable annuities products offered by United, since the business was generating low returns. The deal has been a positive for the company and accretive to its earnings, as the proceeds from the sale had been deployed in core operations, and share repurchases. Intelligent Capital management Torchmark can be considered a shareholder-friendly company as it has been actively increasing shareholders wealth through an ongoing buyback program that began in 1986. The company has also been consistent in generating free cash flow. Though it declined from 2009 2010, due to investment impairments and increased capital requirements at the subsidiaries, it returned to normal levels. For 2015, free cash flow is expected in the range of $355 million to $365 million. We anticipate a continued buyback activity well supported by the availability of abundant cash. By virtue of its intelligent capital management strategy, the company has generated 83% returns for its investors over the past 10 years. Strong Ratings Torchmark also scores favorably with the rating agencies. Fitch Ratings rates the insurer financial strength rating (FSR) and long-term issuer credit rating (ICR) of the company s subsidiaries at A+ and A- respectively and carries a stable outlook. Furthermore, rating agency A.M. Best also confers FSR of A+ and the ICR of aa on the company s subsidiaries. All the ratings reflect investment grade and testify to the sound business fundamentals. REASONS TO SELL Higher Administrative Expenses For the full year, administrative expenses were $180 million or 5.7% of premium. In 2015, the company expects administrative expenses to increase approximately 6% to 7% and be approximately 5.8% of premium. The primary reasons for the increase in administrative expenses are higher pension costs resulting from the required implementation of a new mortality table and further investments in IT systems. High administrative expense might be a drag on the bottom line. Challenges at Liberty National Torchmark s third primary distribution system Liberty National has been underperforming historically. During the fourth quarter, life premiums were flat year over year and life underwriting margin declined 16%. The underperformance of this sales channel was primarily due to its cost structure, which was characterized by high, fixed acquisition costs. Beginning in 2003, Liberty National started to move away from its high fixed cost structure by changing the arrangement of its sales personnel s compensation. The effect of these changes was a major reduction in Liberty National s fixed acquisition costs, which resulted in a more consistent and improved underwriting margin on new business going forward. High level executive changes have also been made recently. Management will continue with its growth initiatives going forward. Equity Research TMK Page 3
However, despite these milestones, the challenge to growth remains and we don t expect this distribution channel to contribute meaningfully to the company s earnings in the near term. Lower Excess Investment Income The company s excess investment income was negatively impacted by Part D to the extent of $2 million in the fourth quarter and approximately $5 million for the full year. For 2015, Torchmark expect excess investment income to decrease about 1% to 3%. At the midpoint of its 2015 guidance, the company is expects a further drag of approximately $6 million on excess investment income from Part D. RECENT NEWS Torchmark Posts In-line Earnings in Q4, Guides for 2015 Feb 2, 2015 Torchmark Corp. reported fourth-quarter 2014 net operating income of $1.00 per share, in line with the Zacks Consensus Estimate. On a year-over-year basis, earnings improved 3%. For 2014, net operating income came in at $4.03, beating the Zacks Consensus Estimate by a penny and improving 6% year over year. Behind the Headlines Torchmark reported total premium revenue of $807.9 million, up 7% year over year, led primarily by higher premium from Medicare Part D operations followed by premium growth in the Life and Health Insurance business. Net investment income increased 3% year over year to $190.7 million. Excess investment income, a measure of profitability, increased 2% year over year to $55.6 million. Torchmark reported underwriting income of $147.7 million, which moved down 3% year over year. The decrease stemmed from a decline in margins in Medicare Part D operations. Administrative expenses decreased 2% year over year to $45 million. The ratio of administrative expenses to premiums was 5.6%, down 40 basis points year over year. Agents, the major drivers of premium growth, saw a 21%, 5% and 13% increase, respectively, in American Income, Liberty National and Family Heritage distribution channels. Segment Update Torchmark's Life Insurance operations saw premium revenue increase of 5% year over year to $493.6 million, attributable to higher premiums written by the distribution channels American Income Agency (up 8%) and Direct Response (up 7%). Life Insurance underwriting income declined 1% year over year to $135.9 million. Net sales of Life Insurance went up 17% year over year. Health Insurance premium revenue (excluding Medicare Part D) was up 5% year over year to $224.7 million, while underwriting income was up 3% year over year to $50.8 million. Total net health sales, excluding Medicare Part D were $72 million, up from $40 million reported in the year-ago quarter. Premium revenue from the Medicare Part D business increased 22% year over year to $89.6 million. Underwriting income saw a drastic 55% year over year decline to $4.5 million. Equity Research TMK Page 4
Share Repurchase Update During the quarter, Torchmark repurchased 1.7 million shares at a total cost of $87.3 million, taking the full-year tally to 7.2 million shares bought back for about $377 million. Financial Update Shareholders equity as of Dec 31, 2014 increased 2.7% year over year to $3.6 billion. Torchmark reported book value per share of $27.91, which was up 8% year over year. Return on equity was 14.9% in 2014, down 60 basis points year over year. Guides 2015 Management now expects earnings between $4.20 and $4.40 per share. The new guidance represents a 5-cent decrease in the midpoint from the previous guidance primarily due to an increase in pension expense, a reduction in the expected Part D margin and lowering of the expected earnings from Canadian operations to account for the recent change in the Canadian exchange rate. VALUATION Torchmark currently trades at 12.4x our 2015 earnings estimate, a 4.6% discount to the industry average. On a price-to-book basis, the shares trade at 1.5x, which is at a 36% premium to the industry average. The valuation on a price-to-book basis looks fair, given that the return on equity is substantially ahead of the industry average. Our six-month target price of $56.00 per share equates to about 11.9x our earnings estimate for 2015. Combined with the $0.51 per share annual dividend, this target price implies an expected total return of 5.3% over that period. Equity Research TMK Page 5
Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Torchmark Corporation (TMK) 12.4 11.3 8.2 7.2 13.3 13.9 7.8 Industry Average 13.0 11.7 9.7 10.8 21.5 N/A 8.5 S&P 500 16.2 15.1 10.7 14.6 17.8 18.4 12.0 Protective Life Corporation (PL) 7.2 5.9 6.2 3.8 N/A 61.2 8.2 Genworth Financial, Inc. (GNW) 10.5 9.6 N/A 11.7 10.0 16.2 6.1 StanCorp Financial Group Inc. (SFG) 12.8 11.6 5.5 8.2 12.8 13.5 7.7 American Equity Investment Life Holding Co. (AEL) 12.1 11.1 8.1 7.7 11.5 13.5 5.9 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low Earnings Surprise and Estimate Revision History ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Torchmark Corporation (TMK) 1.5 1.8 0.9 12.1 0.2 1.0 6.0 Industry Average 1.1 1.1 1.1 7.4 N/A 1.0 3.9 S&P 500 6.2 9.8 3.2 25.4 N/A 2.0 N/A Equity Research TMK Page 6
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of TMK. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1120 companies covered: Outperform - 15.6%, Neutral - 77.0%, Underperform 6.7%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research TMK Page 7