In part 36 of the Dividend Aristocrats In Focus series I take a closer look at the competitive advantage and growth prospects of accident and health insurer AFLAC (AFL, Financial). When I last analyzed AFLAC, I felt the company was significantly undervalued despite positive third quarter results. This article will look into AFLAC’s valuation and overall business prospects. The company’s operations are analyzed below.
Business Overview
AFLAC sells health, life, and cancer insurance in the US and Japan. The company currently generates about 75% of premium revenue in Japan, with the remaining 25% coming from the US. AFLAC is the leading cancer insurer in the world. The company is known as an innovator within the insurance industry as it has found unique places to sell insurance. The company’s policies are sold in post offices and banks across Japan.
Competitive Advantage
AFLAC’s competitive advantage comes from its strong brand recognition in the US. In Japan its competitive advantage comes from its brand strength combined with its network of sales offices and status as the leading health and cancer insurer in Japan. The company’s well received (by some, anyway) AFLAC commercials have built brand name notoriety around the company. In Japan, the company has a similar advertising campaign.
In addition to its brand recognition, AFLAC has built a strong network of independent agents in both the US and Japan. The company’s connections and relationships within the insurance industry have been built over its 59 year operating history. AFLAC’s strong competitive advantages have allowed it to increase its dividend payments for 32 consecutive years. The company
Future Growth Prospects
AFLAC has managed to grow book value per share at a blistering rate of over 10% a year over the last decade. The company’s strong growth has come from share repurchases and premium income growth. A FLAC has repurchased about 1% of its shares outstanding a year over the last decade.
The company’s aforementioned innovations in insurance selling locations are also responsible for strong growth. Going forward, the company will likely grow slower than it has in the past. In its most recent 3rd quarter results, AFLAC saw operating income rise 5.4%. The company also increased its dividend by 5.4%, in line with overall company growth.
I believe AFLAC will be able to maintain operating income growth of 5% to 6% over the long term. This combined with share repurchase gains of about 1% gives the company a per share growth rate of between 6% and 7% going forward.
Dividend Analysis
AFLAC currently has a dividend yield of 2.6% and a payout ratio of just 25%. The company’s dividend is not in any danger of being reduced. The company has significant room to grow its dividend payments faster than overall company growth due to its low payout ratio, although management has not indicated it has plans to increase its payout ratio.
AFLAC’s dividend yield of 2.6% is significantly higher than the S&P500’s dividend yield of 1.9%. The company’s strong historical growth, high dividend yield, and low payout ratio bode well for dividend growth investors seeking years of rising income.
Recession Performance
AFLAC performed well throughout the Great Recession of 2007 to 2009. The company’s premium income rose throughout the recession. Life insurance and health insurance are difficult to cut back on, even in times of economic uncertainty. As a result, AFLAC’s operations are not significantly impacted by recessions.
Valuation
AFLAC currently trades at a PE ratio of under 10. This is significantly below the S&P500’s current PE ratio of about 19.6. Historically, AFLAC has traded at about a 0.8x discount to the S&P500’s PE ratio. At the market’s current level, AFLAC should have a PE ratio around 15. If the market reverted to its historical PE ratio of about 15, the fair PE ratio for AFLAC would fall to 12. On both a relative and absolute basis, AFLAC appears significantly undervalued at today’s prices. I believe patient shareholders will have the opportunity to realize significant capital appreciation as the PE multiple revises upward toward its historical average.
Final Thoughts
AFLAC is trading at such a steep discount to the market because of its exposure to the Japanese yen. The company is also heavily invested in Japanese treasury bonds. Japan has ultra low interest rates and a debt to GDP ratio of about 200%; the highest of any country in the developed world. Japan’s debt burden has caused two decades of stagnant growth for the country. The yen has been quickly losing value to the dollar over the last year, weakening AFLAC’s operations on a dollar denominated basis.
If investors look beyond risks associated with Japan and separate them from the business operations of AFLAC, they will see a strong insurer that continues to grow its constant currency premiums through its corporate sales locations and network of independent agents. AFLAC appears significantly undervalued at this time, has a strong dividend yield, and very solid historical growth. As a result, AFLAC is rated as a Top 20 stock based on The 8 Rules of Dividend Investing .
