If You Own Trupanion (TRUP) Stock, Should You Sell It Now?

Steel City Capital recently released its Q3 2020 Investor Letter, a copy of which you can download here. During the third quarter of 2020, the fund returned 1.6% net of fees, while the S&P 500 Index was up 8.5%. You should check out Steel City Capital’s top 5 stock picks for investors to buy right now, which could be the biggest winners of this year.

In the said letter, Steel City Capital highlighted a few stocks and Trupanion Inc. (NASDAQ:TRUP) is one of them. Trupanion Inc. (NASDAQ:TRUP) is a pet insurance provider. Year-to-date, Trupanion Inc. (NASDAQ:TRUP) stock gained 94% and on October 27th it had a closing price of $72.66. Here is what Steel City Capital said:

“Trupanion (Short): TRUP remains a frustrating short for the Partnership. While already underwater before the 2Q’20 print, the position added insult to injury when shares immediately added more than 20% on the back of what I viewed as an underwhelming earnings print. Management guided total revenue higher by ~$14 million, inclusive of $9 million from the “Other” business and $5 million from the company’s core insurance business.

The best the company could offer up in the way of additional profitability was an incremental $1 million of “adjusted operating margin,” which importantly, is reported before pet acquisition costs (PAC). Guidance was taken from $55 million to $56 million, which is still below the $57 million guided to at the beginning of the year. The full $1 million is coming from TRUP’s core insurance business, with the incremental $9 million of “Other” segment revenue coming without any material profit. Because TRUP has promoted itself as a SaaS-like business, investors are unfazed by the prospect of revenue growth without profits. When you’re valued on the basis of EV/Sales – as opposed to traditional insurance metrics like P/B or P/E – sales growth is paramount. Here on planet earth, TRUP’s shares trade at 1,830x next year’s earnings and 15.7x P/B.

I continue to expect that over the medium term, fundamentals will roll over, thereby depriving this high-growth story of the oxygen it requires to remain on fire. Specifically, I believe TRUP will become increasingly squeezed on both ends of its P&L. Starting with revenue, there continues to be a growing number of competitors entering the market. In many cases, their policies are priced more attractively than the company’s. TRUP can’t afford to cut premiums – its loss ratios won’t allow it – and over time the rising competition should place pressure on both its gross adds as well as churn.

Additionally, rising competition is becoming increasingly evident in the company’s pet acquisition spend. While the company increased guidance for its “adjusted operating margin,” pet acquisition costs are trending disastrously in the wrong direction. During 1H’20, PAC averaged $222, artificially held down by spend of only $199 in the pandemicafflicted second quarter. Management still expects full year average PAC to range from $240-$270, implying an average of $290 in the second half. While management raised revenue and pre-PAC profit targets, there will be very little left over for shareholders after properly accounting for all of the company’s expenses. This is hardly the kind of outlook that justifies the stock’s performance following its second quarter print.

There is another problem. With PAC exploding, the company will quickly find itself outside of its target IRR range of 30-40%. Basic math implies the company will likely end the year spending $300+ per pet in the fourth quarter if PAC is to average $290 in the second half. At these levels, 4Q’20 spend will be 35% higher than the prior comparable period. This rate of growth is unsustainable, and as we progress through 2021, rising PAC will drive IRRs well below 30%. The company will be faced with two choices: Either slow growth to maintain its target IRRs, or maintain growth with economics diminished by higher PAC spend. I don’t believe either will be pretty for the stock.”

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In Q1 2020, the number of bullish hedge fund positions on Trupanion Inc. (NASDAQ:TRUP) stock remained unchanged from the previous quarter (see the chart here). Our calculations showed that Trupanion Inc. (NASDAQ:TRUP) isn’t ranked among the 30 most popular stocks among hedge funds.

The top 10 stocks among hedge funds returned 185% since the end of 2014 and outperformed the S&P 500 Index ETFs by more than 109 percentage points. We know it sounds unbelievable. You have been dismissing our articles about top hedge fund stocks mostly because you were fed biased information by other media outlets about hedge funds’ poor performance. You could have doubled the size of your nest egg by investing in the top hedge fund stocks instead of dumb S&P 500 ETFs. Below you can watch our video about the top 5 hedge fund stocks right now. All of these stocks had positive returns in 2020.

Video: Top 5 Stocks Among Hedge Funds

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Disclosure: None. This article is originally published at Insider Monkey.