Dividend Growth Stock of the Month for March 2020: Unum Group (UNM)

Unum Group (UNM) is a leading insurance provider of financial protection benefits in the United States and United Kingdom. It is the largest provider of disability income in the world.

Unum sells its products primarily to employers for the benefit of their employees. The company was founded in 1848 and is based in Chattanooga, TN.

Unum’s Dividend Record

Unum has a very attractive dividend record.

Unum is a high-yield, fast-growth company. I classify yields above 4% as “high” yields, and for a company in that range, I believe that dividend growth rates over 9% per year are “very fast.”

Unum lowered its dividend in 2003-04, held it steady for a few years, then began raising it in 2009. Annual raises have come every year since, hence its 11-year streak.

The high safety score from Simply Safe Dividends, based on their analysis of factors that impact dividend sustainability, suggests that Unum’s dividend is very safe and unlikely to be cut.

Unum Group’s Business Model and Company Quality

Unum Group provides insurance products for income protection. They sell both group and individual policies. Its biggest markets are in the USA and UK.

Unum’s products cover long-term and short-term disability; life; accidental death and dismemberment; dental and vision; long-term care; and complementary products.

Unum is the largest domestic disability insurer. The majority of its premiums are generated from employer (group) plans. Employers buy them to help attract and retain employees.
Unum depicts its business like this:

The $7.2B paid out in claims in the above chart compares to reported total revenue of $11.6 billion over the same period.

The insurance business model is straightforward. The company assesses risks and underwrites policies to both protect against those risks and make a profit. It charges premiums upfront, providing “float” for use before benefits are paid. The float is invested to make money to fund the eventual benefits and generate profits.

Thus, an insurance business generates business value if its cost of float is generally less than the company would otherwise incur to obtain funds, and if it can generate investment profits on premiums received before they pay claims in the future. The best insurers are good at underwriting and investing.

Unum operates and offers products under several brand names, including Unum US, Unum International, and Colonial Life.

It also provides group pension, individual life and corporate-owned life insurance, reinsurance pools and management operations, and other products.

Unum also offers relevant support services such as benefits communication, enrollment services, and claims support.

Sales are made through field sales personnel, independent brokers, consultants, and independent agencies.

Morningstar awards Unum no moat (sustainable competitive advantage). In general, moats are hard to come by in insurance, because industry competition is heavy, and many products appear to be commodities. Morningstar grants apparently little credit for the network of established relationships with employer/customers (and the resulting “stickiness” of customers) that they often recognize in other fields.

You will notice that my “B” quality grade is higher than the grades from other sources. That’s because I’m seeing Unum through the lens of dividend growth investing. Therefore I place more emphasis on things like steady cashflow and a solid dividend resume than other sources.

And as explained in the next section, I think that Value Line has under-graded Unum’s financial situation.

Here is Unum’s own summary of its business performance and outlook:

Unum’s Financials

Value Line gives Unum Group a low-ish Financial Strength grade of B++, which is their 4th-highest grading level of 9 levels. In this section, we’ll do our own analysis.

Return on Equity (ROE) is a standard measure of financial efficiency. ROE is the ratio of profits to shareholders’ equity.

The average ROE for all Dividend Champions, Challengers, and Contenders is 10%-11%, and for S&P 500 companies it is 14%. The following chart shows Unum’s ROE 2010-2019.

[Source of all yellow-bar charts in this section: Simply Safe Dividends]

Unum’s ROE has generally run in the 10% range, which is acceptable.

Debt-to-Capital (D/C) ratio measures how much a company depends on borrowed money. Companies finance their operations through a mixture of debt and equity (shares issued to the open market) in addition to their own cash flows.

A typical D/C ratio for a large, healthy company is 50%. D/C is a measure of financial risk. All else equal, stocks with high D/C ratios are riskier than those with low D/C ratios.

Unum’s debt runs pretty low, in the low-20s range. That is a positive factor, and it should be noted that unlike many companies, Unum has not run up its debt during the last decade of low interest rates.

As noted earlier, Unum has an investment-grade credit rating.

Operating margin measures profitability: What percentage of revenue is turned into profit after subtracting cost of goods sold and operating expenses?

Per recent research, typical operating margins for S&P 500 companies have been in the 11-12% range.

With a couple of annual exceptions, Unum’s operating margin has run in the low teens, making this an acceptable factor for the company.

Earnings per Share (EPS) is the company’s officially reported profits per share. We want to see if a company has had years when it officially lost money, or if its earnings are steadily increasing, declining, or flat.

Unum has delivered positive, though inconsistent, EPS over the past decade. Its earnings have risen in 6 of the past 9 years, and in no year did the company lose money. There is a general uptrend in earnings, with higher highs and higher lows when EPS dips.

Free Cash Flow (FCF) is the money left over after a company pays its operating expenses and capital expenditures. Whereas EPS is subject to GAAP accounting rules, cash flow is a more direct measure of money flowing through the company. It’s the cash a company has available for dividends, stock buybacks, and debt repayment.

Unum has delivered an outstanding FCF record: always positive, with increases in 6 of the past 9 years.

Share Count Trend shows whether the company’s outstanding shares are increasing in number, decreasing, or remaining flat.

I normally like declining share counts, because the annual dividend pool is spread across fewer shares each year. That makes it easier for a company to maintain and increase its dividend. By buying back its own shares, the company is investing in itself, expanding each remaining share into a larger piece of the pie, and improving all per-share statistics.

An interesting by-product of declining share counts is that the same pool of dividend dollars will support per-share dividend increases year after year.

Unum’s share count trend is outstanding. Its share count has declined every year over the past decade. The number of shares on the market at the end of 2019 was 36% fewer than at the end of 2010. That’s one of the fastest rates of decline that I have seen.

The company has stated that in 2020, they intend to deploy their capital similarly to the way it has been used in the past few years.

Here is a summary of the items above:

I think that Value Line’s 4th-level financial rating for Unum is about a notch too low. I like Unum’s low debt, positive cashflow, and declining share count. The company’s growth rate is not very fast, but as an investor, you can supply your own growth by reinvesting dividends.

I would give Unum an above-average “B” on its financials on an ordinary A-F scale. Here is the company’s financial outlook for 2020, which is consistent with analyst expectations for 5%-6% growth:

Unum’s Stock Valuation

The quality and business strength of a company is one thing. The valuation of its stock is another. We want to buy stocks that are undervalued whenever possible.

As often happens, we find good valuations (and better yields) among stocks whose market price has stalled out.

In the graph below, notice that Unum’s price has dropped over the past two years (red arrow), while its EPS has risen steadily since the Great Recession (blue outline). That combination (rising earnings + falling price), when you can find it, frequently presents attractive entry points for dividend growth investors.

With that background, let’s check Unum’s current valuation. I use four different valuation models, then average them out.

Model 1: FASTGraphs Basic. The first step is to compare the stock’s current price to FASTGraphs’ basic estimate of its fair value.

The basic model uses a price-to-earnings (P/E) ratio of 15, which is the historical long-term P/E of the stock market, to create a fair-value reference line.

In the following chart, the fair-value reference line is orange, and the black line is Unum’s actual price. I highlight both Unum’s current P/E ratio and the reference ratio of 15 used to draw the orange line.

Since the black price line is beneath the orange reference line, Unum is undervalued according to this model.

To calculate the degree of undervaluation, we make a ratio out of the P/Es.

Calculating Valuation Ratio from FASTGraphs
Actual P/E ratio / Reference P/E ratio
5.0 / 15 = 0.33

That suggests that Unum is undervalued by 67%, which I think is the largest margin of undervaluation that I have seen since I have been writing these articles.

We calculate the stock’s fair price by dividing the actual price by the valuation ratio. That gives us $28 / 0.33 = $85 for a fair price.

Remember, valuation is an estimate or assessment, not a physical trait like length or width. We are making a judgement. That’s why I use several models.

Model 2: FASTGraphs Normalized. In the second valuation model, we compare Unum’s current P/E to its own long-term average P/E.

The reference line is now blue, and it is drawn at Unum’s own 5-year average P/E ratio of ~9. That significantly reduces the degree of Unum’s apparent undervaluation.

Using the same formulas as in the first step, we get:

  • Valuation ratio = 5 / 9 = 0.56, suggesting 44% undervaluation
  • Fair price = $28 / 0.56 = $50

Step 3: Morningstar Star Rating. Morningstar takes a different approach to valuation. They ignore P/E ratios and instead use a discounted cash flow (DCF) model for valuation. The DCF model is based on the idea that a company is worth all of its future cash flows, discounted back to the present to reflect the time value of money.

Obviously, no one actually knows a company’s future cash flows. Estimates must be used. My experience with Morningstar is that they have a careful, comprehensive, and conservative process for determining the inputs that they use in their DCF formulas.

Morningstar rates Unum as 28% undervalued, and they calculate a fair price of $38.

Step 4: Current Yield vs. Historical Yield. My last model compares the stock’s current yield to its historical yield. This way of estimating fair value is based on the idea that if a stock’s yield is higher than usual, it may indicate that its price is undervalued.

This chart shows Unum’s current yield (green dot) compared to its 5-year average yield (black line).

[Source: Simply Safe Dividends]

Unum’s current yield of 4.1% is 78% above its 5-year average yield of 2.3%. But I cap this model at a 20% difference to avoid extreme results.

Calculating Valuation Ratio by Comparing Yields
5-Year Average Yield / Current Yield
2.3% / 4.1% = 0.56, but capped at 0.8

Using the capped valuation ratio, the fair price under this model is $28 / 0.8 = $35.

Valuation Summary:

Morningstar gives 3 out of 5 stars (indicating fair value) to Unum’s valuation, even though they state it is 28% undervalued. The reason is not explained, but that’s why I colored Morningstar’s valuation yellow in the table above.

In any event, all four models concur that Unum is undervalued. The average of the four fair prices is $52 compared to Unum’s actual price of about $28.

Even if we toss out the two most extreme valuation models (FASTGraphs models 1 and 2), we still get a fair price of $37, which suggests 26% undervaluation.

By all accounts, Unum is “on sale.”

Miscellaneous Factors

Beta measures a stock price’s volatility relative to the S&P 500. I like to own stocks with low volatility for two reasons:

  • They present fewer occasions to react emotionally to rapid price changes like price drops that can induce a sense of fear.
  • There is research that suggests that low-volatility stocks outperform the market over long time periods.

Unum’s 5-year beta is 0.7, which means its volatility has been, on average, 30% less than the market’s. This is a positive factor.

       Analyst’s Recommendations

In their most recent report on Unum, CFRA gathered the recommendations of 12 analysts covering the stock. Their average recommendation is 2.8 on a 5-point scale, where 3 = hold. This is a neutral factor.

What’s the Bottom Line on Unum?

Unum’s positives:

  • Good dividend resume: 4.1% yield, 10 straight years of growth, fast growth in the 10%-per-year range, and high dividend safety score of 82 out of 100 points.
  • Steady insurance business model primarily centered on income-replacement insurance in cases of disability and illness.
  • Decent company quality, although traditional analysts tend to downplay various aspects of its quality. I give its quality a B rating.
  • Solid financials for a slow-growth company: Moderate debt; decent operating margins and profitability; consistently positive earnings and cash flow; steady decline in share count.
  • Low beta, although its price variation over the past 2+ years has been generally in the down direction.
  • Shares are more than 25% undervalued.

Unum’s negatives:

  • Insurance business generally is felt to have few competitive advantages.
  • Traditional sources such as Value Line and sell-side analysts tend to rate Unum’s business and financial qualities lower than I would.
  • Consistent price drop for over two years may be unnerving to some investors.

In my opinion, at its current pricing, Unum is an attractive opportunity to obtain a solid, investment-grade company, with a good 4.1% yield, steady pace of dividend growth, and high dividend safety.

Nothing in this article is intended to be investment advice. This is not a recommendation to buy, hold, or sell Unum Group. Always do your own due diligence. Think not only about the company’s quality, dividend characteristics, and business prospects, but also about how it fits your personal financial goals.

— Dave Van Knapp

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