Is Lemonade Stock a Buy Now?

Lemonade's (LMND -2.03%) stock price surged 14% during after-hours trading on Aug. 8 following its second-quarter report. The online-based auto, home, rent, pet, and term life insurer's revenue rose 77% year over year to $50 million, which beat analysts' estimates by $2.4 million. Its net loss widened from $55.6 million to $67.9 million, or $1.10 per share, but still cleared the consensus forecast by $0.22.

Do those better-than-expected numbers indicate it's finally safe to buy Lemonade's stock, which remains slightly below its IPO price of $29 per share after its post-earnings pop?

Image source: Getty Images.

Its core growth rates are still cooling off

Back in 2020, Lemonade launched "proportional reinsurance agreements" which ceded 75% of its premiums to reinsurers in exchange for a 25% "ceding commission" for every ceded dollar. Those agreements enabled Lemonade to pass on some risks related to its policies to reinsurers, but they also caused it to generate lower revenue per customer.

Lemonade's reported revenue excludes those ceded premiums, which can fluctuate sharply each year, so its year-over-year growth rates don't always reflect its underlying growth. Instead, investors should focus on its growth in customers, premium per customer, in force premium (IFP), and gross earned premium (GEP) to see how fast it's actually growing.

During the second quarter, Lemonade's number of customers increased 31% year over year to 1.58 million, its premium per customer grew 18% to $290, its IFP rose 54% to $458 million, and its GEP jumped 60% to $107 million. However, all four growth rates have decelerated over the past year.

Data source: Lemonade. YOY = Year over year.

That's probably why Lemonade was so eager to buy Metromile, which adds more auto insurance services to its portfolio of homeowners, renters, pet, and term life insurance products. Lemonade closed that acquisition in late July, and it now expects to generate about 20% of its revenue from Lemonade Car -- compared to just 1% before the deal closed. Its revenue from renters insurance will likely drop from half of its top line to just a third.

In the third quarter, Lemonade expects its IFP to increase 71% to 73% year over year, its GEP to grow 59% to 61%, and its revenue to rise 76% to 82%. All those forecasts include its takeover of Metromile.

At the end of 2021, Lemonade had expected its IFP to grow "approximately 70%" in 2022 after closing the Metromile acquisition. In the first quarter of 2022, it predicted its IFP would grow by "more than 70%" for the full year.

However, Lemonade reduced that guidance after it closed the acquisition. For the full year, it now expects its IFP to grow 60% to 62%, its GEP to increase 63% to 64%, and its revenue to rise 84% to 86%. Those growth rates are still robust, but they suggest that Lemonade overestimated the near-term tailwinds from buying Metromile.

On the bright side, Lemonade's ADR (annual dollar retention) rate -- the percentage of its IFP it retains over the past 12 months -- increased by a percentage point sequentially and year over year to 83%.

Can Lemonade ever narrow its losses?

Lemonade is still growing, but its adjusted gross margin fell sequentially and year over year during the second quarter. Its gross loss ratio declined sequentially but still increased year over year as it dealt with the "strains of inflation" and absorbed higher gross loss ratios from Metromile. 

Data source: Lemonade.

Lemonade continues to bleed red ink, but it laid off 20% of Metromile's staff and divested its enterprise business solutions (EBS) division after closing the deal. It's also reining in its operating expenses, which rose 28% year over year (at a slower rate than its revenue) to $86.9 million during the second quarter.

But on an adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) basis, Lemonade still expects to post a loss of $69 million to $74 million in the third quarter and $240 million to $245 million for the full year. Therefore, investors shouldn't expect it to approach break-even levels anytime soon.

Is Lemonade reasonably valued yet?

With a market cap of $2 billion, Lemonade trades at about eight times this year's sales. That price-to-sales ratio seems reasonable relative to its growth expectations, but it will likely lose its momentum in the second half of 2023 after it laps the Metromile acquisition. Most traditional insurers, like Allstate and Travelers, trade at around one time this year's sales.

Therefore, it's difficult to tell if Lemonade is actually cheap or expensive in this market. However, I'd personally avoid this speculative company until its gross margins stabilize, its gross loss ratios decline, and it significantly narrows its net losses.