Unum Stock: Remains Cheaply Valued Despite Rally (NYSE:UNM)

Unum (NYSE:UNM) has rallied 64% over the last 12 months thanks to an improving business environment and its extremely cheap valuation level a year ago. When a stock enjoys such a steep rally, many shareholders are tempted to take profits. However, it is important to realize that the stock remains remarkably cheaply valued. Therefore, investors should refrain from taking profits on Unum.

Business overview

Unum is an insurance company that provides various financial protection benefit solutions in the U.S., the U.K. and Poland. The company offers group long-term and short-term disability, group life products and many other insurance products.

Just like most insurance companies, Unum has faced two strong headwinds in its business in the last three years, namely the coronavirus crisis in 2020-2022 and the surge of inflation to a 40-year high last year. Due to the pandemic, Unum faced an abnormally high number of death claims in recent years.

As if the pandemic was not enough, Unum faced another hurdle last year, namely sky-high inflation, which imparted a double hit on the insurer. First of all, high inflation led the Fed to raise interest rates aggressively. Consequently, the mark-to-market value of the investment portfolio of Unum significantly decreased last year. In addition, excessive inflation greatly reduced the present value of future cash flows and thus it compressed the price-to-earnings ratio of the stock. The latter was also pressured due to the increasing risk of an upcoming recession. To cut a long story short, Unum has faced strong headwinds in recent years.

Fortunately, the worse seems to be behind the company. Thanks to the massive distribution of vaccines worldwide, the pandemic has finally subsided. As a result, Unum currently receives much fewer COVID claims than it did in recent years. In the third quarter, its death claims slightly increased sequentially but they were much lower than they were in each of the previous two years. Moreover, as the proportion of COVID deaths is now about 15%, it is likely to have a much lower effect on the total performance of the company than it had in 2020-2021.

The improvement in business conditions was evident in the results of Unum in the third quarter. The company grew its operating earnings per share by 28% over the prior year’s quarter, from $1.60 to $2.04, primarily thanks to a great improvement in COVID-related claims as well as solid premium growth. Thanks to its recovery from the pandemic in the first nine months of the year and its sustained business momentum, Unum reaffirmed its guidance for 40%-45% growth of operating earnings per share in the full year.

It is also worth noting that Unum exceeded the analysts’ estimates by $0.10. It has thus exceeded the analysts’ consensus by a wide margin for 4 consecutive quarters. This is just a confirmation of the sustained business momentum of the insurer.

Not only have the aforementioned headwinds begun to subside, but Unum has begun to enjoy some tailwinds in its business. First of all, the pandemic led employees to realize their financial fragility and thus appreciate the merits of insurance. Moreover, Unum greatly benefits from rising employment levels and rising wages, which result in higher premiums for the company. These are key factors behind the 3.9% growth in premiums reported in the latest quarter.

Moreover, the above headwind from 40-year high inflation has begun to attenuate. Since it peaked last summer, inflation has moderated every single month thanks to the aggressive interest rate hikes implemented by the Fed. As the central bank has clearly prioritized restoring inflation to its long-term target of about 2%, even at the expense of economic growth, it will probably achieve its goal sooner or later. It is also worth noting that high interest rates enable Unum to invest its float at higher yields and thus enhance its investment income.

Furthermore, as Unum holds the bonds of its investment portfolio until they mature, its mark-to-market losses are only paper losses, which will gradually disappear as bonds approach their maturity date. It is also remarkable that the company has significantly improved the quality of its investment portfolio, as it has reduced the portion of non-investment grade bonds from just under 9% to just under 6% since the end of 2020.

Analysts seem to agree on the sustained recovery of Unum from the downturn in the last few years. They expect the company to grow its earnings per share by 44% this year and by another 3.5% per year on average in 2023-2024.

Valuation

Unum has rallied 64% over the last 12 months, primarily thanks to a significant improvement in its business landscape. Nevertheless, the stock remains attractively valued. To be sure, Unum is currently trading at a price-to-earnings ratio of only 6.7. Even better, the stock is trading at only 6.2 times its expected earnings in 2024. These valuation levels are much lower than the average price-to-earnings ratio of 8.0 of the stock over the last decade.

As inflation is abnormally high, the cheap valuation of Unum can be somewhat justified in the short run. However, as mentioned above, thanks to its aggressive policy, the Fed is likely to restore inflation close to its normal range this or next year. When inflation subsides, the valuation of Unum will probably revert to its historical average. This means that the stock has 29% upside potential (=8.0/6.2 – 1) over the next two years.

Dividend – Share repurchases

Unum raised its dividend by 10% last year and thus it is now offering a 3.2% dividend yield. The insurer has grown its dividend for 14 consecutive years. It has grown its dividend by 10.0% per year on average over the last decade and by 7.7% per year on average over the last five years. Given the severe downturns that Unum has been facing in the last three years, its dividend growth record is certainly admirable.

It is also important to note that Unum proved exceptionally resilient in the Great Recession, as it kept growing its earnings per share throughout that crisis. Given its resilience to downturns and its exceptionally low payout ratio of 23%, Unum is likely to continue raising its dividend meaningfully for many more years.

Moreover, Unum has been consistently repurchasing its shares during the last decade. During this period, the company has reduced its share count at a 3.2% average annual rate. As the stock is trading at an exceptionally low price-to-earnings ratio, its share repurchases are likely to greatly enhance shareholder value. Overall, Unum is likely to keep offering attractive shareholder distributions for the foreseeable future.

Final thoughts

Despite its rally in the last 12 months, Unum remains attractively valued and thus it is likely to highly reward investors in the upcoming years. The only caveat is the high volatility of the stock during downturns. Due to this volatility, the stock is suitable only for the investors who can ignore short-term stock price volatility and remain focused on the solid business fundamentals of the company and its cheap valuation.