Lemonade (LMND -4.70%) has been one of the most disappointing companies for investors over the last year and a half, with the stock down around 91% since hitting an all-time high of 183.26 on Jan. 11, 2021. Investors are unimpressed with Lemonade's inability to live up to its many promises since coming public in the middle of 2020.
Can Lemonade reverse its downtrend? Here's one key reason Lemonade can make a comeback.
Image source: Getty Images.
Bundling can increase Lemonade's profitability
One of Lemonade's biggest hurdles as a public company has always been that the cost of acquiring a customer exceeds what it expects the customer to spend over time. And Lemonade can never become profitable as long as that remains the case.
One way to fix this problem is by using an old sales practice known as product bundling -- which occurs when several products are packaged together and sold as a single unit for one price. The tactic of product bundling has historically been used in many industries to sell more products, increase profits, and decrease marketing costs -- precisely what Lemonade needs. And there is early evidence that Lemonade is successfully using the tactic.
The first quarter of 2022 was the first full quarter that Lemonade offered the mega bundle (home/renters, pet. life, and car) in the market. But the offer was available only in two states -- Tennessee and Illinois. Early data comparing Illinois to areas without the mega bundle showed Illinois achieved 40% higher bundle rates. Additionally, management saw the average dual-product customer spending more than the average single-product customer by 3-to-1; the triple-product customers ratio was 7-to-1. For customers with all four products, it was 9-to-1.
Accordingly, the improved bundled customer spending helped raise the annual dollar retention (ADR) to 90% in Illinois versus 82% for Lemonade overall. Lemonade introduced the ADR metric in the first quarter of 2021 shareholder letter as a measure of Lemonade's ability to retain customers and sell additional products to those customers over time. Ideally, investors would like to see the ADR climb to more than 100%, showing that Lemonade gains more revenue from existing customers than the revenue lost due to churn. And the Illinois data is a good step in that direction.
While the bundle data is still early, if Lemonade can replicate and improve Illinois results in other states, it would be well along the way to improving its profitability.
However, Lemonade's technology has not lived up to the promise
Lemonade's initial allure to many investors was the idea of leveraging technology, data, and artificial intelligence (AI) to make insurance more affordable, more efficient, and a better experience for customers.
The gross loss ratio is one fundamental way you can measure the company's AI's ability to price risk, approve applicants, and settle claims. Unfortunately, since the beginning of 2021, Lemonade's loss ratio has been mostly above its target range of 75% -- a prime reason investors have sold off the stock.
Source: Lemonade first quarter 2022 shareholder letter.
Complicating matters further is inflation, which hurts results for all insurance companies as claims immediately adjust for inflation. Yet an increase in insurance rates can take months to counter inflation's effects on claims. When Lemonade submits changes in pricing, underwriting, and other adjustments to regulators, it takes time before those changes get final approval. And even after Lemonade implements the modifications, it takes even more time for the company to see any results.
The bottom line
Lemonade is selling at 6.75 times 12-month trailing sales, which is substantially lower than the 95.7 times 12-month trailing sales that the stock was trading at when it hit its highs in January 2021. Yet, despite valuation dropping off a cliff, the company's revenue growth remains strong. For example, in the first quarter of 2022, in-force premium (IFP), a measurement of active policies, grew 66% to $419.0 million compared to the first quarter of 2021 -- growth that came on the back of the customer count increasing by 37% to 1,504,197.
Additionally, Lemonade has submitted 100 applications for rate increases to regulators over the past year to compensate for inflation. As a result, the company expects insurance pricing to better align with risk as regulatory approvals occur. In addition, management said it already sees signs that business generated in the first quarter of 2022 will have a loss ratio well within the 75% target. If that proves true moving forward, the stock will likely rebound. As a result, if you have a high-risk tolerance, Lemonade could be worth a small investment at current prices.
