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Aflac - Value Idea Contest
Posted by: Gaffey (IP Logged)
Date: July 16, 2012 09:55AM

This is my first submission to the value contest. Seeing AFLAC (AFL) at the top of the Undervalued-Predictable screener got me very interested. I’m an engineer and I invest as a hobby. I’ve never had occasion to dig deep into the workings of an insurance company, so this was a bit of a learning experience for me. Here’s what I’ve learned about Aflac.

Aflac Inc. is a provider of supplemental insurance in the U.S. and Japan. In the U.S., accidental death/disability insurance and cancer insurance are responsible to 65% of the U.S. segment revenue. In Japan, cancer and other health insurance are responsible for 69% of the Japan segment revenue.





The market seems to be grossly undervaluing Aflac. The first place to look is the financial statement. Earnings and free cash appear strong. The company has very little debt. I was puzzled.

We see in 2011 that AFLAC experienced a drop in return on equity. Dupont analysis was applied to see why. Asset turnover seems to be on the decline, but nothing jumped out that says I shouldn’t invest in Aflac. Five factor analyses uncover that Aflac pays almost no interest on debt.



Insurance companies collect premiums from customers and then invest those premiums in bonds. Perhaps the market is undervaluing the company because of the quality of its investments. The market could also be undervaluing Aflac because the bond market is currently inflated.

Here are some charts that expose Aflac’s investment exposure:







Aflac has a significant portion of it’s portfolio in financial institution securities. 35% of it’s financial institution exposure is in European banks, other than the UK. It works out that approximately 10% of the companies assets are in European banks. If we assume all these assets come off the books completely, only 1% to 2% of revenue should be affected. The European debt crisis does not seem to be the reason the market is under-valuing Aflac.

Aflac management is keenly aware of its exposure to European debt and is working to reduce this exposure.
At this point I had to go back to the basics. The majority of Aflac’s revenue is generated in Japan. That means they’re collecting revenue in yen, not dollars.

Let’s convert 10-year earnings to yen, instead of dollars.



EBITDA growth doesn’t seem nearly as impressive in yen, as earnings in dollars. The bump in earnings in dollars is due to dollar value destruction over the past decade.

Since earnings in yen are lumpier than earnings in dollars, applying the standard Ben Graham multiplier of 8.5 times EPS for a no-growth company, you get $36 per share for Aflac, based on 2011 earnings. Add in a 2.5% dividend yield, and you get a price of $46 per share. The current share price is $43.

Aflac devotes a great deal of money to currency exchange programs. The majority of its derivative portfolio is in foreign exchange currency swaps. Aflac also tries to minimize currency fluctuations on the value of net assets. They accomplish this by investing a portion of Aflac Japan's investment portfolio in dollar-denominated securities and by the parent company's issuance of yen-denominated debt (as a result, the effect of currency fluctuations on net assets is reduced).

Other business risks to Aflac include:

• The Dodd-Frank law, which gives regulators more authority to place significantly more regulations on insurance companies that could have be a grave threat to the financial stability of the U.S. Aflac doesn’t think it will fall under this provision of the Dodd-Frank law.

• De-regulation of insurance in Japan. Insurance companies that would otherwise have competed with Aflac in Japan will be allowed to enter the supplemental insurance market.

Near-term growth prospects in the U.S. are expected to be relatively flat due to the economy. Aflac feels that in the long term, its insurance products will have solid demand.

Conclusion: Aflac is a stable company in good financial health. There is some risk due to European debt exposure, but the exposure seems to be immaterial to cash flows. EPS growth is primarily dependent on the yen/dollar exchange rate. In the near term, it seems the likelihood of the dollar rising in value relative to the yen is low, given historically low yields on 10-year Treasuries. Aflac is a solid investment in an uncertain market selling at a slight discount to fair value. Investors should have an eye on exchange rates as a stronger dollar (weaker yen) will destroy value.

Disclosure: I am currently long Aflac.


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Aflac - Value Idea Contest
Posted by: Invest E Gator (IP Logged)
Date: July 16, 2012 06:46PM

Hi Gaffey, I'm somewhat familiar with AFLAC. They are a fantastic company operationally, and the management is dweebtastic, but I find too much unpredictable guesswork with them. First, the earnings in Yen makes for a very confusing situation. the Yen has been steadily increasing against the dollar for decades, and I can't tell if this is going to continue or not. Second, all that debt in Japanese treasuries, they are the most indebt nation on the planet, if I remember correctly. Also, the rest of that bond portfolio is downright confusing. So far they have managed to survive decades of financial crisis after financial crisis, but it's difficult for me to look at those bonds and be sure that they are always going to be able to land on their feet. Last year, there was some talk of Buffett trying at a 22 billion dollar acquisition that fell through. I'm almost certain it was them, he would surely be able to put them to good use as a moat generating machine.


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Aflac - Value Idea Contest
Posted by: mcwillia (IP Logged)
Date: July 16, 2012 07:06PM

Adding to your value thesis...

De-regulation in Japan occurred some time ago, and this has not resulted in a flood of competition for Aflac. When the barriers were lowered, banks didn't enter Alfac's turf, rather they invited Aflac into theirs. The reason is Aflac's unbeatable low-cost leadership position, as discussed in other Gurufocus posts and in Aflac's analyst briefing materials. Any value contest submission on Aflac should also include a nod to Aflac's underwriting profit margin, presently at over 6%. Aflac uses this advantage to virtually shut down most of its competitors. Remember, Aflac's main competitors are not U.S. companies, rather they are:

1. Nippon Seimei
2. Dai Ichi Life
3. Meiji Yasuda
4. Sumitomo
5. Alico
6. Daiyo
7. Sony
8. Tokyo Anshin

How Good Is Aflac Under the Hood? 600% More Cost Efficient Than Rivals.

Re-posting from some prior writings of mine, there is little real competition anywhere in sight (except possibly the Japan Post, and the State Dept/U.S. Foreign & Commercial Service Corps. just sat on them, telling Japan's government that letting Post compete against Aflac would derail Japan's TPP bid!) According to Aflac's financial analyst briefing materials, Aflac administers 5366 policies per employee, while its four larger competitors (by assets) each administer less than 900 policies per employee. It is more than 600% more efficient than its clumsy competitors.

Its Good to be the King

What can you do when you are 600% more efficient in admin? You can charge drastically lower premiums, with higher profit margins, and pay higher commissions to sellers, all at the same time. Net result? You capture 70% of the market and become the largest insurer in Japan by number of policies issued. It's that simple.

Competing Against Zombies...Insurers With Hi Fixed Costs & Negative Yields.

Why are Aflac's competitors so weak? First, most use in-house door-to-door salesmen, an inefficient remnant of the 1960's. And these are drawn from one of the priciest work forces in the world. By contrast, Aflac sits back and lets agencies, and increasingly, the banks, sell its policies, particularly through bank branches, which, being desperate to generate fee income, have been selling the hell out of these policies. Aflac's hapless competitors also are also stuck paying 5 to 6% dividends on life insurance and annuities they wrote back in the 90's and 2000's, while being forced to accept sub 2% yields on their own investments in Japan Government Bonds and other fixed income instruments (yes, a negative spread. sucks to be them). Finally, these clumsy firms are forced to buy debt and equity investments in their 'partner' companies, members of their Keiretsu business groupings, and these investments are perennially underperforming dogs. It is sister-kissing acts like this that render their investment returns even worse than had they simply invested in (ugh...) Japanese real estate, Japanese equities, or Japanese debt.

Aflac has avoided such investments, has no such lugubrious sales force, and has no legacy negative spread issues. It has investment portfolio issues of its own, but these do not really impact its strangle hold on the Japan market, despite how they have spooked the market. The simple fact is that Aflac could lose a third of its investment portfolio and still rake in operating profits in Japan endlessly. The portfolio loss would have little impact.

(Sorry to re-post, folks. Long Aflac)


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Aflac - Value Idea Contest
Posted by: mcwillia (IP Logged)
Date: July 16, 2012 07:26PM

I also think Buffett tried to buy Aflac, and may be still in discussions. Here's the math...

Berkshire would probably offer to buy 80% of Aflac at a 40% premium or thereabouts, say $58/share, leaving the Amos family with its present 20% of the voting power and retaining Dan Amos as CEO, a typical Berkshire play.

The Math: 80% x (20 Bn x 1.4) = 80% x 28 Billion = $22.4 Billion.

I don't think management should consider an offer below $75/share, however, and they certainly would not be interested in a sub $62 price, IMHO. Moreover, they were not as shaken by the Euro crisis as he may have hoped. They also probably prefer to give Kirsch and the consultants a stab at improving the portfolio before just handing it to Buffett for a relative firesale price.



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Aflac - Value Idea Contest
Posted by: Dr. Paul Price (IP Logged)
Date: July 16, 2012 07:28PM

Last year's radioactivity leakage could be a huge negative in their cancer policy claims expense over time. It's impossible to quantify but a very real risk to their profitability. AFL is trying to bring down the percentage of revenues from this source but it's still a very large chunk of total sales.


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Aflac - Value Idea Contest
Posted by: mcwillia (IP Logged)
Date: July 19, 2012 03:38PM

Stockdocx99,

You're on to something...Aflac has exposure to the irradiaiton not through policy benefits so much as through its portfolio holdings...

Teppco Bonds...Eww.

It owns $214 Million worth of Toden (Tokyo Denki, AKA Teppco) bonds, and dozens of other bonds from issuers who likewise hold Toden. These once favorite income gushing bonds are now below investment grade and depend on the good graces of the Japanese Government to pay off at par. This indeed represents some risk and its hard to tell from the financials whether it is properly hedged. Still, its not a material risk to Aflac's franchise. One must remember that these bonds are ingrained throughout the Japanese financial system and its insurers, banks, and pension funds, so the odds of the Diet or Okurasho permitting them to default is actually pretty low. They are owned by powerful bondholders who in part control Japan's financial and political interworkings.

As for policy benefits for cancer policy holders, most folks forget that Aflac's payouts are fixed yen amounts, not cart-blanch coverage of medical bills, and so the payout amounts would actually be modest. Moreover, Aflac has over-reserved against these risks, on an historical basis, and any losses would be partly offset by the reserve. Second, Aflac will certainly modify future coverage so as to increase premiums for this kind of risk or add a specific rider. Meanwhile, Aflac will be able to invest the proceeds of these policies for many years and generate significant income. Next, organic growth in other areas, significantly in its WAYS product, will further put Aflac beyond any possible real damage to its core business from this event.

Lastly, a cancer scare across Japan drives huge amounts of new sales, directly into Aflac's maw, since Aflac controls over 70% of this market, and remember that Japan has a national paranoia regarding cancer. So the Fukushima event will probably make, not cost, Aflac money.

So, from a value point of view, the Fukushima event does not really matter. Aflac will be able to continually generate and compound huge profits even in a worst-worst case scenario regarding these cancer policy exposures.


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