Motley Fool Money - Is Lemonade A Lemon?

Episode Date: April 4, 2024

 Investors soured on the insurance company. But, what happens if the business can become cash flow positive? (00:21)Yasser El-Shimy and Deidre Woollard discuss: - Why big trucks might become less popular. - If slowing EV production makes long-term sense. - The power demands of artificial intelligence. (16:17) Matt Frankel and Ricky Mulvey take a look at insurance tech company Lemonade and if it can go from sour to sweet. Companies discussed: LMND, MET, BYD, GM, F, TSLA, GOOG, GOOGL, CEG Host: Deidre Woollard Guests: Yasser El-Shimy, Matt Frankel, Ricky Mulvey Producer: Ricky Mulvey Engineers: Rick Engdahl, Dan Boyd Disclosure: A High-Yield Cash Account is a secondary brokerage account with Public Investing, member FINRA/SIPC. Funds from this account are automatically deposited into partner banks where they earn a variable interest and are eligible for FDIC insurance. Neither Public Investing nor any of its affiliates is a bank. US only. Learn more at public.com/disclosures/high-yield-account Learn more about your ad choices. Visit megaphone.fm/adchoices

This episode is brought to you by Indeed. Stop waiting around for the perfect candidate. Instead, use Indeed sponsored jobs to find the right people with the right skills fast. It's a simple way to make sure your listing is the first candidate C. According to Indeed data, sponsor jobs have four times more applicants than non-sponsored jobs. So go build your dream team today with Indeed. Get a $75 sponsor job credit at Indeed.com slash podcast. Terms and conditions apply.

EV market slowdown a trend or a blip. Motley Fool Money starts now. Welcome to Motley Fool Money. I'm Deidro Willard here with Motley Fool analyst Yasser El Shima Yasser. How's your Thursday going? It's going well so far. Thank you. Ricky and Jim talked Tesla deliveries earlier this week,

but now we've got numbers from just about everybody else or at least a lot of the big ones. So we have this complicated picture of what's happening in terms of auto sales, where the companies are going. It is really interesting, and I want to dive into it. I want to start with Ford for a little bit. I mean, sales were up, but they had this rise, 77% rise in the sale of the Ford Maverick hybrid.

Overall, EV sales pretty strong, but there's also discounting happening. And there's something else happening that you brought up, which is a migration, perhaps, away from some of the big, heavy trucks that have sort of really been driving the market. I'm wondering what's happening. happening there. I mean, because as the country, the U.S., we love us some trucks. That's absolutely

true. I mean, just a few years ago, I remember, you know, when we talked about Ford, we always talked about sort of its leadership position in the pickup truck segment, especially with the F-150 being the best-selling pickup truck in America. Now we're talking about Ford Maverick hybrid, you know, when discussing Ford. And that's quite a shift. But, you know, just to kind of, um, put a bow on this. I don't know if you've been on, you know, on the market for a car lately, either new or used, but cars are becoming increasingly unaffordable. Oh, yeah. They can set you back a fifth more than they did about five years ago.

And that, that trend has not, you know, shown any signs of reversing. I mean, the pace of increasing has definitely come down. But we're not, we're not seeing the kind of retrenchment or, you know, you know, of car prices that we need to see in order for cars to become affordable again. And this is made even worse by the fact that interest rates are a lot higher than they used to be just a few years ago. So that makes car affordability absolutely difficult for people. So if I'm on the car market and I'm trying to decide which car to buy here, you know, I want to buy a smaller car that's going to cost me less money.

I wanted to be a little bit gas efficient, you know, economical. because I don't want to spend a lot of money at the gas station. Guess what? Gas prices are also up. And I may not really want to be buying an EV because EVs are a lot more expensive than the traditional ice vehicles or internal combustion engine vehicles. So they are more expensive. There's not really a lot of charging infrastructure out there.

And people have range anxiety, people who could be in the Midwest or, you know, and some of the tougher climates out there may have some concerns about their cars in the winter specifically. So people are looking for that sweet spot that combines, you know, good mileage, lower price, and, you know, smaller cars that may have a hybrid option. Those are hitting the sweet spot for a lot of car buyers. This is so funny to me because for the last couple of years, it's been like the death of the sedan. and the major car makers have discontinued so many of those models, and now they're like, no, wait, we like these.

And it makes sense because, I mean, we're seeing a rise in loan delinquencies, too. But, you know, Ford recently announced that they're sort of, they're pumping the brakes a little bit on the EVs because the hybrids are selling better. And we've heard about this before with battery plants being, you know, delayed or scaled back. there's definitely something happening here, isn't there? Absolutely. I think, you know, automakers who have invested in hybrid technology, and that can be the traditional hybrid that we can think of like a Toyota Prius, where it's just generative braking, generates power to the battery and so on, or the plug-in hybrid, which is a more recent invention, those kinds of companies that have made these investments can now

stand to reap their rewards. And Ford and Toyota are kind of like at the forefront. front of that trend. With prior investments, they had made other card companies, on the other hand, that had made a lot of investments in transitioning all in on EVs may be caught out here. They have the wrong mix for the wrong market, and they may struggle as a result. As optimistic as I may sound here, kind of about where Ford might be, I think there is a word of caution, which is that Ford is, I don't know Ford might be over reading into the moment. that we're currently going through by delaying the rollout of its electric vehicles. I mean, we just read about the signature electric pickup truck, I think, code name T3,

that Ford is going to roll out, that that has been delayed until 2027 instead of being released in 2025. I wonder if that's going to create an opening for competitors like a RAM, for example, which has been kind of running a close second or head-to-head with Ford and some of these pickup trucks to take a lead in this market, especially as it unveils a new generation of plug-in hybrids, all electric pickups, I think they called the RAM revolution. They're going to release those later this year, and I just wonder what kind of reception the market will give them. I want to talk about one that we don't talk a lot about. We talk about Tesla. We talk about the big three, but we had a report from Volvo. We don't really think about Volvo that much these days, but they had a pretty strong sales,

year-on-year electric sales in Europe up 22% of 34% in March alone. But they're having trouble selling in China, which I thought was interesting because they're majority owned by a Chinese company, Gile. So with Volvo, rather, they said they're going to be fully electric by 2030. I mean, they announced that in 2021. They haven't walked it back, but do you think it's possible that they would? I think it's possible. I don't know that that, again, would be very prudent.

Look, I think Volvo is in a better position than some of their American counterparts, perhaps, and that's maybe because a lot of their production is sold in Europe. So, around half of Volvo car sales are in Sweden, the UK, Germany, and other European countries. These countries have made huge investments in building out that networking infrastructure I was talking about. They also enjoy population density around cities in a way that the United States doesn't really have that. So it's a bit of tougher task to build out that infracture to cover the entire country. So Volvo is catering to that market. They have good reception in that market to their EV options.

But trying to predict whether these trends will continue into 2030 and therefore Volvo should shift all of its production into EVs is a bit, can be a bit tricky to predict at this point. I think if I were Volvo CEO, which I'm not, I would probably try and not put all of my eggs into that EV basket. I mean, the U.S. market is the second biggest market for Volvo. And again, I don't know that by 2030, you know, EV adoption is going to be that massive across the U.S. to the point where Volvo can just, you know, afford to only sell EVs and not offer any alternatives. I want to switch us over to talking a little bit about electricity from a different angle, because you and I were talking yesterday about data centers and energy usage.

So I was at this conference this week called Retcon, which is a real estate technology conference. And they were talking about office real estate, of course. And everything was coming about to data centers. Like, oh, we'll put data centers in these old office buildings. And the more I started to think about that, and the more I heard people talk about the power. grid and the strain that's happening here. This is fascinating to me as something is starting to happen and is only going to get bigger. And I'm wondering how to think about it, both as a person who may share a power grid with these data centers, as well as an investor.

Well, let's just say I'm so glad that we installed solar panels late last year. I, if I, you know, I think utility bills are going through the roof, most likely over the next 10 years or so. So the demand that these data centers are going to create on the electricity grid and the power grid across much of the world is going to be very, very significant. Already we had a secular growth market for data centers. And keep in mind, data centers right now already consume almost 1 to 2% of the entire global power production. When we have this kind of like generative AI revolution in the works, you know, where you are going to have to. to have data centers dedicated to training large language models. They come with extreme power requirements. They are going to consume even more power than the traditional data centers

that are already consuming so much of our power. So, you know, energy is really the 800-pound gorilla in the room with a whole generative AI discussion. I think, you know, over the Constellation Energy, for example, which is a utility company here in my home state of Maryland, They're projecting the data center electricity consumption is going to almost quadruple over the next 60 years compared to 2022 levels. The question that investors and even policymakers should really be asking is, where will this power come from? And from an investing perspective, I'm really interested in two sides here. First, the power generation side and second, the power savings side. Power generation, we can look at utility companies, you know,

operating in, especially operating in areas with like heavy concentration of data centers, such as Northern Virginia, for example. You can also look at alternative energy options that stand to benefit from this kind of energy bonanza, if you will, including solar, wind, and definitely nuclear companies. So that's kind of on the power generation side. On the power savings side, we're going to actually have to look at at companies that make the computational chips, as well as the storage devices that are used in these data centers to make some new innovations in their power consumption so that they

can actually reduce the requirement, the power requirements to operate these things in a significant way. We're already starting to see the likes of Nvidia even announcing that their next generation of chips are going to require a lot less electricity than is currently the case with H-100 and H-200 generations. And also on the storage side, we can see companies like pure storage really innovating on this front and offering very compelling, low-power storage device options for data centers. Yeah, it's fascinating. One of the things I'm thinking about, too, is, okay, if these prices go up, that's not great

for me as someone who's sharing the power grid. But then I'm also thinking about how these companies make all of this pay. And you know, you shared with me this story from the financial times about Google maybe putting some of its AI powered services behind a paywall. You know, we have to pay for all of this computational power somehow. And I think all of these companies are really trying to figure things out. It's fascinating what's happening with Google. And if AI becomes search, I mean, one of the things I've heard is like an awareness of the fact that if I'm searching something on Google versus searching something on Open AI or Gemini or anything else, I'm using a lot more power if I'm using AI and that power has to be paid for somehow. So what is Alphabet looking

at with this? So I think you, I mean, you make a very good point. To run a search query on a Chad GPT or on any other generative AI model, it requires a lot more power and therefore a lot more cost to run that query. Compared to the traditional online search model that Alphabet has kind of championed through Google, where you just type in whatever question you have, and they have an algorithm in the works that's already kind of stored there and based on keywords, and they just, you know, they throw at you. a lot of blue links littered with ads.

And you just have to kind of navigate your way through that in order to find what you're looking for. My sense is that this kind of era of search is going to change and change rapidly. I think people are going to be a lot more interested in actually getting answers to their search queries as opposed to a lot of blue links. And that's a huge problem for Google on alphabet, of course. I mean, this is kind of like the mother's ship of innovator dilemmas here. I mean, you're being disrupted with the generative AI models like Claude and chat GPT.

Now, Alphabet has a choice. It can either double down on its traditional search and say, you know what, this is our bread and butter, we're going to keep it going. It has insanely profitable, insanely high profitable margins, and we're just going to keep it going. Or it can try and compete with the likes of Chad GPT and Claude and offer, you know, its own generative AI model, codename, Gemini, at this point. They've already gone through so many different names of what their AI model is going to be. But the point is, it's a very tough choice to make because by offering Gen AI search options to their customers, Google's in fact enabling that very trend, which is disrupting them. And of course, they can only succeed in one of two things here.

They can only try and maintain their market share in search, and that is again going to be through offering these Gen AI models that customers are increasingly demanding. But the downside to that is that that is going to come at the expense of their margins. So they cannot continue to be as profitable as they have been or maintain the same. kind of market share that they have been. So one or the other is going to have to be sacrificed here. And that's kind of, I think, probably the reason why we're hearing the news about Alphabet trying to offer a subscription for Gemini in order to kind of maybe tease out a new business model.

I think competition is going to be strong. And I'm skeptical that Alphabet is going to be able to work it out in terms of maintaining market share as it has traditionally been. retaining profit margins to be as high as they had traditionally been. No matter what happens, we're going to lead a lot more power. Thanks for your time today. You're very welcome. I'm happy to be here. If you're early in your career and looking for insight, inspiration, and honest advice, listen to the Capital Ideas podcast, hear from Capital Group professionals about leaning into

the differences that make you unique, making decisions that last, and what it means to lead with purpose. The Capital Ideas podcast from Capital Group, available wherever you listen, published by Capital Client Group, Inc. Is Lemonade, the insurance tech company, a lemon? My colleague Ricky Mulvey caught up with Motley Fool contributor, Matt Frankel, for a check-in on the company and what it would take for lemonade to turn around. All right, Matt, Bill D wrote to us at our email, Podcasts at Fool.com. That is Podcasts with an S at Fool.com.

Can one of the episodes give a deep dive slash review on Lemonade sometime soon? I know there are probably a fair number of full members holding this and wondering whether slash when to get out. I'm one of those members, Bill, so I am more than happy to do this segment with Matt Frankel, who follows this company closely. But for those who are less familiar, I want to give some setup. Lemonade is an insurance tech company that aims to disrupt traditional insurance by using an AI platform to give better quotes, faster claim payouts.

It built a customer base through renter's insurance and was looking to expand from there. The other side is that there's a charitable component where the stuff, They don't pay out goes to charity. But for a lot of the full members listening, what they know is that the share price went from about 160 bucks in 2021 to about 16 bucks today. Matt, let's start in 2021. What were the expectations for Lemonade at that point? Lemonade was a, their IPO was completed kind of during the meme stock craze.

So that's just some context there when everything was just going up. up and up, and there's, you know, valuations kind of were a little, you know, looking back, in retrospect, they were kind of not accurate. But generally, the business has done what it was supposed to. I'm sure we'll dig into that in a little bit. But, I mean, the story's great, right? That's what really attracted investors. You mentioned the charitable component. I love what they're trying to do. Buying insurance is clunky at best. The claims process is really clunky with most insurers and Lemonade kind of aims to solve that and has solved that with its products. It's customer satisfaction is just off the charts good.

And they're growing the business pretty rapidly. If you compare the numbers now to the numbers then. Yeah, kind of the story is we're going to get younger folks in the door with sort of, I would say, a softer, more relevant marketing pitch, get them with renter's insurance, and from there we'll sell them car insurance, homeowners insurance, pet insurance, which they have a partnership with Chewy for. So, we'll start. I know we don't like to start with the stock, but how has the stock story changed over the past few years? Then, why have so many people soured on lemonade? Well, as you mentioned, I like the joke soured right there.

There you go. But as you mentioned, the stock is down roughly 90% from the 2021 peak. Again, in retrospect, it never should have been a $160 or $180 stock or wherever it ended up peaking. But, I mean, you can look back at a lot of the companies that went public during that time and make a different valuation case than the one that was being made at the time. But the stock story, people are souring on the company, one, because it's taking longer than expected for Lemonade to become profitable. That's a big one. If you think of what was happening in 2021, when you could essentially borrow money for free. Lemonade did at one point.

One of the smartest moves they ever made was they issued about a billion dollars of new debt at the peak and at a $160 stock valuation and essentially pay no interest on it. But now the worry is that they're going to run out of money before they're profitable. This is not the type of environment. an unproven insurance startup wants to be raising money in. So that's really the biggest issue why people have soured on it. Running out of money would be a significant problem. CEO Daniel Schreiber has said, I think, in the last quarterly earnings that they expect

to be cash flow profitable this year. There is a business behind this stock, though, and it's improving its loss ratio. It's writing more premiums. So is it just, is it that race to run out of money? Is there something else going on? It seems to be on track to at least become cash flow profitable if you listen to management. So here's the numbers. They have about $945 million in cash and equivalence on their balance sheet.

They can't use all of it. Insurance companies need to have reserves and things like that. But the management says that they're going to have positive cash flow by late 2025 is the latest quote. And adjusted EBITDA profitable, not even real EBIT dot profitable, by 2026. So, you know, it's a little bit of a gap they have to bridge. And you're right, their loss ratio is improving. It's still not where it needs to be.

In the fourth quarter, look, it was 77% as opposed to a 75% target. The first and fourth quarters of every year are a seasonally strong time for insurance. Generally, the big natural disasters happen in the summer. So it's a seasonally strong time. So you definitely watch the second and third quarter. I don't think it's going to be 77% for the year. If it was, that would be a very big accomplishment. But that's really what investors are looking at.

So there's seasonality to watch. I want to get into basically two other significant, I would say, bare takes on the company. One I've heard that I don't quite understand, so I'm asking you, is that the company has to buy reinsurance for a large portion of its policy exposure. It can't essentially cover the claims that it's paying out. I know a lot of insurance buy reinsurance, but is this? Is this uncommon for a consumer insurance company? How should us regular investors understand this component of the business? Think of reinsurance as insurance for insurance companies.

You're right. Most insurance companies use this. This is how, say, if a homeowner's insurance company wants to limit its exposure to hurricane losses, it might buy a reinsurance policy that caps its own out-of-pocket losses at, say, a billion dollars, and then the reinsurance policy would kick in and pay the rest. It's not used. for a company to essentially exclusively, but almost exclusively rely on reinsurance. I think it's 75% of the premiums Lemonade takes in go right to pay reinsurance. So it's kind of the central part of the business model, which makes it more of a capital-light business, more of a predictable cash flow business. But you're right, it's not as common

to be that reliant on reinsurance policies. Would you like to see Lemonade do more of its own? underwriting then. If it's a tech company, you don't want to have a ton of that on the balance sheet, but if you're an insurance company, you sure do a lot of underwriting. Well, if with their reinsurance strategy, they can hit that 75% target sustainably, then I'm fine with the way they're doing things right now. But they're not. If you remember about two years, this was speaking of 2021, you had the big Texas freeze. That was the kind of the big event in 2021, and it shot their loss ratio up to something like 120% in the fourth quarter.

That's not good. It doesn't matter how much better you make the insurance process. If you're not good at underwriting, what are you doing? So that's really a big concern. It's trending in the right direction. The reliance on reinsurance could end up being a bit of an issue, but the biggest reason their loss ratios are so high, just for context, is since that time, they've rolled out a lot of new insurance products.

They have life insurance now. They have car insurance. They're not just a renter's insurance company. Homeowner's insurance has become a much bigger part of the business, and it's these newer types of insurance that are responsible for the elevated loss ratio as they're letting these kind of cohorts of insurance customers season. It remains to be seen if they can make it a profitable business model long term. So even if it becomes profitable, a lot of those earnings might be spread out. And I got no issue. I understand why companies need to issue new shares, new equity. In the case of Lemonade, though, their average shares outstanding have about doubled since 2020, according to

looking at stockdata.fool.com. But which investors make of this should they expect sort of that issuance to be pulled back as this company becomes a little more mature? Well, to be fair, some of that doubling was the IPO itself. Some of the doubling was that secondary offer they made when the stock was through the roof, which was a great move. But a lot of it is stock-based compensation, which I, as from an investor standpoint, one of my biggest complaints with Lemonade's business model is their stock-based compensation seems kind of ridiculous. In 2024, they're expecting about $60 million of stock-based compensation. This is for a company whose total market caps is about a billion dollars, and it's not profitable. If you want to reward stock-based

compensation because your employees are making money for you, Great. But you can't dilute the stock by 6 to 10% a year with stock-based compensation long-term and expect to deliver market-beating returns for investors. You just can't. Yeah. So, I guess for those holding onto it, what are you looking for in Lemonade's results for this year, or at least the first three quarters? Yeah. So I already mentioned the seasonality is making the fourth quarter numbers that we just got look good. So I'm going to be watching. during the summer, season the second and third quarters for their underwriting results,

see if that loss ratio continues to trend downward even in a not-seasonably favorable time. They're not going to get the stock-based compensation under control this year, unfortunately. But I want to see that their adjusted EBITDA loss and their cash flow is trending toward those targets. The cash flow positive in 2025, adjusted EBITDA profitable in 2026. And if they're heading in those directions, that's a good thing. And the stock could look like, a bargain at these levels. But if not, it's going to be a pretty binary outcome, I think. Let's answer Bill's question. Right now, the stock's beaten down. There's some things to watch. Are you selling? Are you adding while it's beaten down? Are you holding to see how the story plays out?

I am holding. I'm in kind of wait and see mode. I've kind of, like a lot of investors, have a lot less appetite for speculation than I did in 2021 and 2022, understandably so. But I love the management. I love the idea. I just want to see some execution. And if we start seeing that in the next couple quarters, I might be a buyer. So for the investors who are a little less in on the speculation or a little less eager to speculate, are there any other insurance companies, maybe more established, maybe profitable that deserve their attention that you're watching? I mean, there are some good opportunities in insurance right now. One of my largest insurance stock in My portfolio is MetLife, ticker symbol, MET, you know, tried and true business model.

They're more of a traditional insurance company, but are really good at their job. And it's a great dividend stock right now. And I've owned that one for about 10 years and have no plans to sell. Perfect. Matt Frankel. Thank you for your time and your insight. It's always fun to be here. As always, people on the program may have interests in the stocks they talk about.

And the Motley Fool may have formal recommendations for or against. so don't buy ourselves stocks based solely in what you hear. I'm Deidreau Bullard. Thanks for listening. We'll see you tomorrow.