New York City-based insurance company Lemonade (NYSE:LMND) gets headlines as a potential disruptor in an industry that has long been dominated by a handful of names. Lemonade stock had its IPO on July 2, when it opened at $50.06. By July 6, it reached $96.51. Now it is hovering at $62.
Lemonade was launched in 2016 as an insurance-tech (“insurtech”) start-up. Through its digital and artificial intelligence-based platform, Lemonade offers property and casualty insurance, specializing in renters and homeowners insurance for homes, apartments, condos, and co-operatives.
It also provides health insurance for pets. It is a fully licensed insurance carrier whose main reinsurer is Nephila Capital, which is the largest insurance-linked securities (ILS) fund manager globally and is owned by Markel (NYSE:MKL).
In the coming weeks, I expect Lemonade stock to trade within a range, between $50 and $65. If you’re an investor with a time horizon of two to three years, you may consider buying the dips in the shares, especially if it goes below $55.
How Q2 Results Came
On Aug. 11, the company announced its second-quarter results. It was Lemonade’s first earnings release since its IPO in early July. Quarterly revenue saw a YoY increase from $13.8 million to $29.9 million. The number also beat analysts’ estimates. Second quarter net loss narrowed to $21 million (or $1.77 per share) from net loss of $2.09 per share in the corresponding quarter of 2019.
The company announced that less than 1% of its customers opted to defer payments as the novel coronavirus impacted the economy. Retention, click-through and conversion rates online all held steady.
However, the Street raised eyebrows when management issued weak guidance for the third quarter. The insurer now expects third quarter revenue of $14-15 million, below the analysts’ expectations of $15.2 million, and 2020 revenue of $86 million to $88 million, below the analysts’ expectations of $88.9 million.
Following the release of the financial results, Lemonade stock initially was down over 10%. It has recovered some of the losses in the following sessions.
Lemonade Is Growing Fast
Since its early days, Lemonade has been regarded as a disruptor, in part due to its use of AI and behavioral psychology. It handles over 30% of its support requests through AI. It is able to fulfill a substantial percentage of claims almost instantly. Its main target market is tech-savvy millennials. A large number of its customers are also first-time insurance buyers.
Lemonade’s business model is mostly different than that of other established insurers. The insuretech group keeps a flat premium fee of 25% up front. Thus the remaining 75% of the premiums becomes available for claims. And excess funds get paid to a charity of customer’s choice at the end of the year. That is where behavioral economics comes into play.
Other insurance companies, however, keep what is left after paying out claims. In other words, denying claims whenever possible benefits those companies.
As a result, Lemonade is growing fast. Consumers seem to be satisfied with both the use of technology and the business model. Recent research by Elie Ofek and Danielle Golan of Harvard Business School highlights that by “embracing a model that removed any incentive to deny claims and that let customers pick causes to donate leftover money … the company was able to grow at an impressive pace.”
It’s a Competitive Industry
It is important to remember that insurance is a heavily regulated industry where competition is high. Some of its largest competitors include, Allstate (NYSE:ALL), Berkshire Hathaway’s (NYSE:BRK.A,NYSE:BRK.B), Liberty Mutual, Progressive (NYSE:PGR), and Travelers (NYSE:TRV).
They are all established insurance companies with long histories of innovation. Could these companies also adopt an AI technology that could challenge Lemonade’s mode of operation?
According to PwC’s 23rd Annual Global CEO Survey of late 2019, which was conducted before the global outbreak of the COVID-19 pandemic, “The top three opportunities CEOs are prioritizing and investing in over the next 12 months are customer experience, core technology transformation and intelligent automation (including robotic process automation).”
Yet, in this competitive environment, the Softbank (OTCMKTS:SFTBY)-backed insurer Lemonade is still-loss making. And market participants are increasingly becoming skeptical of recent IPOs that are continually loss-making.
Many will cite the example of Uber (NYSE:UBER) which was also backed by Softbank and is still unprofitable. Uber had its IPO in May 2019 at an opening price of $42. It is now around $30.
Put another way, being loved by young customers does not always translate into being loved by long-term investors, who may in fact belong to the older generation of baby boomers. Older people may not necessarily decide to become customers of and investors in Lemonade and its shares. And a new company such as Lemonade would need the backing of a wide range of investors for the stock price to make new highs in the coming quarters.
If Lemonade’s management does not soon offer a clear path to profitability, many investors may decide to say on the side.
The Bottom Line
While Lemonade is definitely growing, it’s still far from being profitable. And with unprofitable companies, when the initial hype of a stock’s IPO is over, investors typically begin to scrutinize the fundamental metrics. As a result, the share price usually becomes volatile due to speculation about the given company’s growth prospects.
In the coming days, I expect Lemonade stock to trade in a range, mostly between $50 and $65. Long-term investors would like to see the stock go and stay over $65. Yet short-term traders will likely keep it below $60.
If you are not yet a shareholder, you may want to consider the stock if it falls to $55 or below.
Those who already own LMND stock may consider hedging their positions with monthly at-the-money (ATM) or slightly in-the-money (ITM) covered calls. By adopting such a strategy, investors can benefit from a rally in the shares and at the same time have some protection from further declines.
Meanwhile, the company may be acquired, which would create substantial value for early investors in Lemonade stock.
Tezcan Gecgil has worked in investment management for over two decades in the U.S. and U.K. In addition to formal higher education, including a Ph.D. degree, in the field, she has also completed all three levels of the Chartered Market Technician (CMT) examination. Her passion is for options trading based on technical analysis of fundamentally strong companies. She especially enjoys setting up weekly covered calls for income generation. As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.
