Third quarter 2011 saw Aflac (AFL) shares trade as low as 31 and change. Today’s earnings release shows that during this time, Aflac did not lose its cool. In fact, it performed extremely well. Notably, during the quarter, it:
· Increased its float by 7%
· Earned a nearly 6 % underwriting profit
· Boosted operating earnings by 14.5%
· Stockpiled an extra 1$/share of cash
· Bought in 1% of outstanding shares
· Boosted its dividend 10% (raising for the28th? Year in a row, or is it 29?)
· Wrote down only ten basis points of its investment portfolio (that’s .1%)
· Reduced its Held-for-Sale securities account 4%
· Reduced holdings of PIIGS 18%
· Reduced euro zone peripheral financial holdings 7%
· Earned $1.66 in operating profit/share.
This last statistic is interesting. When the shares traded near $31, this represented a 21% earnings yield on the price — a yield growing at a rate of over 13% per year. Now it may be observed that nearly 6% of this was due to currency gains as the yen appreciated. True enough. The currency-neutral growth rate was only 7.2%. But this is still astounding.
On that basis, Aflac was yielding over 20% and growing it at 7.2% annually. Few investments can boast that kind of return, much less grow it. The good news is that at its current quotation, Aflac is still a great value, and much of the mystery relating to euro zone exposure is now put to rest.
The Value of the Parts
As an exercise in breakup value, one could look at the U.S. operations and value them alone, to see what the remainder of the company is selling for. The U.S. operations have a book value of about $10.43 a share, and annual premium revenues/share of another $10.20. Warren Buffett used to thumbnail the value of insurance companies by summing the book value per share, which the company already owns in bonds, with the premium income, on the assumption that the company would eventually earn the premium. The sum for Aflac is $20.63 per share. Looking at it from another point of view, the U.S. operations earned around $1.20 after tax. Valued at Aflac’s average historical P/E multiple of 17, this comes to about $20.50. Either way you look at it, the U.S. business, which is less than one-third of Aflac, is worth about twenty bucks. That means that the entire Japanese business was selling for around $11 during the third quarter low, while generating over $5 a share in earnings and featuring a book value of over $22 a share.
In other words, you could pay full price for the U.S. business and get the entire Japanese operation for a P/E of just over two. That’s right, a 50% earnings yield. The inverse valuation is even more compelling. Buy the Japanese operations at full price and get the entire American operation thrown in for free and have change left over.
Aflac’s Incredible Factory
Of course, there is a different way of looking at Aflac, one which focuses on the value of the investment portfolio. With Europe nearing the abyss, it looked as if Aflac could have been forced to write down so much of its bond portfolio that the equity of $25/share would be entirely drained away. It would then have been forced to dilute shareholders and raise equity, killing the share price. Indeed, this was the prevailing expectation. However, Aflac’s bond portfolio is not the company’s source of share value. It is merely the “factory” which generates the 20% (and growing) return on investment. As long as the portfolio stays above the required RBC capital ratio, the write downs do not impair Aflac’s ability to make another 20% or more year after year, ad infinitum. Nobody minds when an industrial company writes down its factory by 7% annually, or must put 30% of earnings into its factory annually in order to simply keep it going another year. Aflac’s “factory” is really no different, but it generated a 20% return on investment and needed only one tenth of one percent write down in order to do it. Call it "wear and tear." Aflac’s RBC ratio is presently over 500%. Exactly how much portfolio write down would it take to "kill" the golden goose (or duck)?
A Real Risk…Yen Hyperinflation
Aflac has no real risk in either Europe or the Fukushima irradiation. These are phantoms which compelled Mr. Market to offer the business to savvy investors for a foolishly low price. The real risk, as usual, is not being talked about much, namely the destruction of the yen. That currency is presently a safe haven and is popularly believed to be on a permanent strengthening trajectory. The difficulty here is that the Japanese government is quickly approaching insolvency, accelerated by the earthquake, rising yen, disappearing population, quagmire economy and annual collapse of its government. It is presently in debt over 200% of GDP and is funding that debt with bonds issued at sub-market interest rates. It can do this only because the Japanese buy most of the bonds and have historically been net savers. All this is coming to an end. The Japanese population is shrinking drastically and the aging folks are spending down their savings. The inflection point is not far away. After that, Japan will be forced to sell bonds to fund the government debt at competitive global rates, and this will almost instantly render Japan insolvent. The only solution will be massive devaluation of the yen and hyperinflation, along with a GDP collapse, as the government prints yen to satisfy its debts.
What happens to Aflac in this situation? First, it is a real risk and investors must have hedges in place. But assuming the yen falls to 500 per dollar, a true collapse, Aflac’s U.S. operations are still worth $20 a share, and its Japan operations earn about $1 per share, which comes to $17 a share at the historical P/E valuation. All told, the total collapse of the yen would probably leave the shares worth somewhere in the range of $35 a share. This presumes, of course, that neither operation grows in the future. And did we mention that the shares were trading under $32 this quarter?
The Final Analysis
Buffett often says that calculus is unnecessary for investing, as a true bargain jumps off the paper at you without need of fancy math. Here is a good example. A healthy, growing company which prints money year in and year out, selling for five times earnings. It is the best-of-breed, market leader, trustworthy management, enviable growth for decades. It gets paid 6% to invest its float of over $90 billion...what is not to like? Hedge the yen and buy this excellent company while it is still on sale, before Warren Buffett does.
Disclosure: long Aflac, of course.
· Increased its float by 7%
· Earned a nearly 6 % underwriting profit
· Boosted operating earnings by 14.5%
· Stockpiled an extra 1$/share of cash
· Bought in 1% of outstanding shares
· Boosted its dividend 10% (raising for the28th? Year in a row, or is it 29?)
· Wrote down only ten basis points of its investment portfolio (that’s .1%)
· Reduced its Held-for-Sale securities account 4%
· Reduced holdings of PIIGS 18%
· Reduced euro zone peripheral financial holdings 7%
· Earned $1.66 in operating profit/share.
This last statistic is interesting. When the shares traded near $31, this represented a 21% earnings yield on the price — a yield growing at a rate of over 13% per year. Now it may be observed that nearly 6% of this was due to currency gains as the yen appreciated. True enough. The currency-neutral growth rate was only 7.2%. But this is still astounding.
On that basis, Aflac was yielding over 20% and growing it at 7.2% annually. Few investments can boast that kind of return, much less grow it. The good news is that at its current quotation, Aflac is still a great value, and much of the mystery relating to euro zone exposure is now put to rest.
The Value of the Parts
As an exercise in breakup value, one could look at the U.S. operations and value them alone, to see what the remainder of the company is selling for. The U.S. operations have a book value of about $10.43 a share, and annual premium revenues/share of another $10.20. Warren Buffett used to thumbnail the value of insurance companies by summing the book value per share, which the company already owns in bonds, with the premium income, on the assumption that the company would eventually earn the premium. The sum for Aflac is $20.63 per share. Looking at it from another point of view, the U.S. operations earned around $1.20 after tax. Valued at Aflac’s average historical P/E multiple of 17, this comes to about $20.50. Either way you look at it, the U.S. business, which is less than one-third of Aflac, is worth about twenty bucks. That means that the entire Japanese business was selling for around $11 during the third quarter low, while generating over $5 a share in earnings and featuring a book value of over $22 a share.
In other words, you could pay full price for the U.S. business and get the entire Japanese operation for a P/E of just over two. That’s right, a 50% earnings yield. The inverse valuation is even more compelling. Buy the Japanese operations at full price and get the entire American operation thrown in for free and have change left over.
Aflac’s Incredible Factory
Of course, there is a different way of looking at Aflac, one which focuses on the value of the investment portfolio. With Europe nearing the abyss, it looked as if Aflac could have been forced to write down so much of its bond portfolio that the equity of $25/share would be entirely drained away. It would then have been forced to dilute shareholders and raise equity, killing the share price. Indeed, this was the prevailing expectation. However, Aflac’s bond portfolio is not the company’s source of share value. It is merely the “factory” which generates the 20% (and growing) return on investment. As long as the portfolio stays above the required RBC capital ratio, the write downs do not impair Aflac’s ability to make another 20% or more year after year, ad infinitum. Nobody minds when an industrial company writes down its factory by 7% annually, or must put 30% of earnings into its factory annually in order to simply keep it going another year. Aflac’s “factory” is really no different, but it generated a 20% return on investment and needed only one tenth of one percent write down in order to do it. Call it "wear and tear." Aflac’s RBC ratio is presently over 500%. Exactly how much portfolio write down would it take to "kill" the golden goose (or duck)?
A Real Risk…Yen Hyperinflation
Aflac has no real risk in either Europe or the Fukushima irradiation. These are phantoms which compelled Mr. Market to offer the business to savvy investors for a foolishly low price. The real risk, as usual, is not being talked about much, namely the destruction of the yen. That currency is presently a safe haven and is popularly believed to be on a permanent strengthening trajectory. The difficulty here is that the Japanese government is quickly approaching insolvency, accelerated by the earthquake, rising yen, disappearing population, quagmire economy and annual collapse of its government. It is presently in debt over 200% of GDP and is funding that debt with bonds issued at sub-market interest rates. It can do this only because the Japanese buy most of the bonds and have historically been net savers. All this is coming to an end. The Japanese population is shrinking drastically and the aging folks are spending down their savings. The inflection point is not far away. After that, Japan will be forced to sell bonds to fund the government debt at competitive global rates, and this will almost instantly render Japan insolvent. The only solution will be massive devaluation of the yen and hyperinflation, along with a GDP collapse, as the government prints yen to satisfy its debts.
What happens to Aflac in this situation? First, it is a real risk and investors must have hedges in place. But assuming the yen falls to 500 per dollar, a true collapse, Aflac’s U.S. operations are still worth $20 a share, and its Japan operations earn about $1 per share, which comes to $17 a share at the historical P/E valuation. All told, the total collapse of the yen would probably leave the shares worth somewhere in the range of $35 a share. This presumes, of course, that neither operation grows in the future. And did we mention that the shares were trading under $32 this quarter?
The Final Analysis
Buffett often says that calculus is unnecessary for investing, as a true bargain jumps off the paper at you without need of fancy math. Here is a good example. A healthy, growing company which prints money year in and year out, selling for five times earnings. It is the best-of-breed, market leader, trustworthy management, enviable growth for decades. It gets paid 6% to invest its float of over $90 billion...what is not to like? Hedge the yen and buy this excellent company while it is still on sale, before Warren Buffett does.
Disclosure: long Aflac, of course.
