Description

Hi, guys --

INTRODUCTION

I've been trying to come up with a way to communicate just how bad NWLI's business is; the best I could do is "tanker bad". They sell life insurance and annuities. This is a highly regulated and extremely competitive business. Low interest rates have crimped demand and crushed spreads. It's not a good business to begin with and the environment is just terrible. NWLI's returns are further hampered by their investment policies -- ~90% IG bonds -- and extraordinary level of over-capitalization. I guess an 800% risk-based capital ratio counts as extraordinary. In addition, NWLI faces challenges replacing its most profitable line which is in runoff. And if that wasn't enough, the stock is illiquid and the company controlled by the geriatric founder, although actual operations are conducted by his extended family, most notably his younger son, who is chairman and CEO.

Hmm, trying to think if I left anything out ... well, those are the highlights, I mean lowlights, anyway. Oh, wait, I forgot about covid. They're a life insurer and people have been dieing a lot lately, that's another headwind all right.

The appeal here is that it's really cheap at 31% of book($703)/34% of book ex-AOCI($631). The combination of low price, overcapitalization & extremely conservative investments also means that it's pretty safe. "Intrinsic value risk" -- the risk that you're paying more per share than an intelligent businessman would pay to purchase the entire company -- is low and will remain so for a long time. The balance sheet should allow the investment to remain unimpaired even in the face of huge global crises like the GFC and the coronavirus pandemic.

I STAND ON THE SHOULDERS OF GIANTS

It's time to acknowledge the prior art here. NWLI has been written up 3 times before:

Value Investors Club / NATIONAL WESTERN LIFE -CL A (NWLI)

spike945 2012 $139

Great call, I encourage you to read it. It's clear, concise and gives some sense of the history.

Value Investors Club / NATIONAL WESTERN LIFE -CL A (NWLI)

thrive25 2015 $253

Seemed mostly to be focused on cheap + rates going up ... alas, they did not.

Value Investors Club / NATIONAL WESTERN LIFE GROUP (NWLI)

venetian 2020 $291

Singularly ill-timed reccomendation, coming just before the sh*t hit the fan. Venetian I think was trying to quantify and capitalize the over-capitalization.

TURN AND FACE THE STRANGE

I strongly urge you to read spike945's writeup right now, because I'm going to talk about what happened over the last decade, and his writeup is a succinct summary of NWLI back then. I'd copy and paste it, but that would be plagiarism. I'll wait until you're done.

...

Back? Good. Since spike945's writeup, major events have been:

1: The founder was replaced by his son.

2: They reorganized into a holding company structure. This is why you might have difficulties getting long term financials, many data providers don't do the appropriate splicing.

3: They withdrew from the international markets. This is the "most profitable line which is now in runoff" referenced in the first paragraph.

4: They made a decent sized acquisition in 2019. Ozark Life looks to me to have a good sales platform; they use affiliate marketing ("Speaking to you as a fellow Christian, have you considered your godly financial duties to your wife and children?") to push the Balanced Plan, which consists of a mutual fund + life insurance. Given the premium to book paid, I assume NWLI thinks they can grow this.

5: At the beginning of 2021 they entered into a reinsurance contract that had the effect of raising their risk based capital ratio from ~530% to ~800%.

I'll be referring to most or all of these events in the "upside" section, so keep them in mind.

DOWNSIDE

This isn't really "downside", because of course this thing could go to zero. But what happens if the status quo remains in place? 

This is probably the only # I'm going to use in this relentlessly non-quantative-even-for-me writeup. From Q3 2011 through Q3 2021 NWLI's book value ex AOCI grew at 6%. I'd expect that number to be lower going forward due to the international book running off -- call it 5%? Is that bad?

I'm not sure! Given the balance sheet, I think the right comparable for NWLI equity might be preferreds, not equity. I took a look at some life insurance preferreds and eyeballed yield-to-worst at ~4%. I don't want to say that status quo NWLI is *better* than say, MET 5.25 CALLABLE 1/26, there's too much going on, but if I *wanted* to buy some random life insurer preferred, I would listen to a "buy NWLI instead" pitch.

"Crappy life insurance preferred" isn't a bad downside.

UPSIDE

There's obviously tons of optionality here because the stock is so cheap. Random samping shows some other life insurers up 40% TTM. Could that happen to NWLI? Why not? Random sampling shows some other life insurers trading >= book ex-AOCI. Could NWLI trade at 50% of that metric? Why not?

But mostly -- things that can't go on forever won't. Old man Moody was a Depression child who came from an era when it was both possible and maybe made sense to eschew short term gains and instead hold your investments to the highest standards. Don't get me wrong, that might still make sense, but it's no longer possible. The younger Moody seems to recognize this.

If you go back to the "Turn And Face The Strange" section, you'll see that every one of these changes has to do with increasing strategic flexibility. (As a side note, NWLI is also increasing its invesnting flexibility as well.) 

This isn't that hard: 100% of assets in IG + being grossly overcapitalized does not work. Here's a link to NWLIC's AM Best ratings that I hope helps make my point:

https://nwl-edge.nationalwesternlife.com/nwl-com/OM_06811_083021.pdf

NWLIC has an A (not AAA) from AM Best despite having the strongest balance sheet. Why? Well, AM Best considers operating performance and business profile as well -- JUST LIKE EQUITY INVESTORS -- and there NWLIC is only average at best. NWLI could actually improve its all important rating by degrading the balance sheet if that would increase profitability.

Back to increasing strategic flexibility -- Old man out, young(er) man in, check. Holding company, check. Acquisition, check. Reinsurance to bolster balance sheet, check. Why do we need strategic flexibility? Because the company has not been able to grow the book on its own, and because an 800% RBC ratio makes no sense, and because a 90% allocation to IG also makes no sense.

I'm running out of steam here. If you read Moody's commentary in the annual reports and the brief quarterly PRs, he talks a lot about growing the company. In the 2019 annual there was a whole side bar about how his sainted father created the company through acquisitions to begin with. So I think the company will use its balance sheet to grow through acquistion. Ordinarily this might be bad, but at these levels? Absolutely not, go for it, let's just pray it takes a couple of years for the wheels to fall off.

I'm not necessarily a fan of acquistions, would probably come down on the other side. But this company needs to deploy capital, and this stock needs a catalyst, any kind of catalyst. And I think the acquisition catalyst will appear over time.

Yours,

Bowd

Catalyst

Move excess capital into acquisitions over time.