Going into the company's second quarter, Lemonade (LMND 1.44%) was on the chopping block for many investors. Shares turned sour, falling more than 83% off their all-time highs. For a good reason, too. Lemonade has struggled with its cash burn and profitability, all while reporting a suboptimal gross loss ratio for several quarters in a row.
However, this quarter showed signs of hope. The concerns investors have had with the stock -- while still present -- are potentially easing. Of course, there's still a long road ahead for Lemonade to become worthy of buying again, but the company just gave existing shareholders three reasons to hold on a little longer.
Image source: Getty Images.
1. Profitability is looking up
Lemonade's appealing business model is what attracted many investors. The company uses artificial intelligence (AI) to make insurance determinations, and it does so in a way that disrupts the insurance industry: It is trying to make the process enjoyable for consumers. The company has seen rapid adoption with AI engines that can complete application determinations and process claims in minutes and a fee structure that aligns Lemonade's incentives with its customers. In Q2, Lemonade had almost 1.58 million customers, up 31% year over year.
While the company has seen stellar adoption of its products, Lemonade has struggled with profitability. In 2021, Lemonade's net loss was $241.3 million, and the company's free cash flow burn reached $154 million, compared to only $1 billion in cash and investments on the balance sheet and revenue of $128 million.
The company still isn't profitable -- it has lost $143 million and burned $84 million so far this year -- but Lemonade is cutting back on growth initiatives and hiring expenses to improve profitability.
As a result of this reduced spending, management believes it can live off its current cash balance until the company reaches profitability, and that is a big step in the right direction. Given the company's history of cash burn, many investors thought Lemonade would have to raise capital, which would be difficult and expensive in the current macroeconomic environment.
2. One major metric is moving in the right direction
Lemonade's business model is much different from traditional insurance models. Rather than getting paid by excess premiums, Lemonade keeps a flat fee. If premiums are left over after Lemonade takes its fees and pays claims, the excess cash goes to charity. This policy effectively destroys the incentive for Lemonade to deny as many claims as possible, which insurance companies are notoriously known for.
Therefore, Lemonade's gross loss ratio -- the ratio of money paid out in claims to gross earned premium -- is vital. The AI systems must get their risk-rating analysis on target in order to run a viable business. The company has been targeting a loss ratio of 75% or lower for the long term. However, it hasn't gotten close to that in recent history. For example, in Q4 2021 and Q1 2022, Lemonade's loss ratio was 96% and 90%, respectively.
In Q2 2022, however, it continued to trend downward to 86%. This ratio is still higher than investors would like it to be, but it shows a continued trend of moving in the right direction.
However, the gross loss ratio is a backward-looking metric. Looking forward, Lemonade expects the lifetime loss ratio of its Q2 2022 customer cohort to be 68.4%, well below its long-term goal.
3. Lemonade closed the Metromile buyout (at an absolute steal)
Lemonade also closed its acquisition of Metromile, a pay-per-mile car insurance company. What's special about this deal is that Lemonade bought this business at a bargain. For $145 million in stock, Lemonade got:
- 100,000 new customers
- $110 million of in-force premiums
- Car insurance licenses in 49 U.S. states
- Data from half a billion trips
In addition, Lemonade got $155 million in cash, so it paid less in stock than the cash it received. In other words, Lemonade got tons of data to refine its AI engine for car insurance, along with a sizable customer base and licenses for car insurance, all for (basically) free.
Why I'm not buying more Lemonade yet
While this quarter was encouraging, this still might not be the time to buy Lemonade shares. The stock has been in the doghouse recently because of its cash burn and stumbles with its loss ratio. While those are improving, they still aren't in a great place. Shares aren't cheap either: Lemonade still trades around 12.6 times sales.
It might not be the right time to buy Lemonade, but the positive business trend does give existing shareholders hope about the future. Q2 showed a clear path to profitability and that Lemonade's worst days might be behind it. While investors should keep Lemonade on a short leash, this quarter gave investors reason to hold onto shares for a few more quarters.
