Aflac Incorporated (NYSE:AFL) is a supplemental life, health, and accident insurer with operations in the United States and Japan. The company generates about 75% of its revenue in Japan, with the remaining 25% coming from the United States.
Aflac is a very shareholder-friendly company. The company has increased its dividend payments for 32 consecutive years. This makes Aflac a Dividend Aristocrat. The company’s commitment to share repurchases is equally as impressive.
CEO Daniel Amos had this to say about Aflac’s share repurchases in the company’s most recent quarterly report:
“We continue to believe our capital strength puts us in an excellent position to repatriate approximately ¥200 billion to the United States for the calendar year 2015, which reinforces our plan to repurchase $1.3 billion of our common stock in 2015. As we said at our financial analysts briefing in May, we believe that over the next few years, we’ll be able to increase the capital available for deployment (emphasis added).”
$1.3 billion is a lot of money for a company Aflac’s size. Aflac currently has a market cap of $27.8 billion. $1.3 billion in share repurchases comes to 4.7% of the company’s current market cap. Add in the company’s current dividend yield of 2.4%, and Aflac plans to return 7.1% to shareholders in the form of share repurchases and dividends in 2015.
Aflac expects to generate earnings-per-share of around $6.00 in 2015. The company plans to pay out about $4.50 per share in dividends and share repurchases in 2015, for a total payout ratio (including dividends and share repurchase) of 75%.
Aflac’s Growth Prospects
Aflac grew earnings-per-share at 10.3% a year over the last decade. The company managed solid earnings growth in a difficult time for insurance companies. This growth includes both the Great Recession, and a period of rapidly falling interest rates.
Low interest rates cause insurers to generate less profit from their insurance float. The higher interest rates are, the more profits can be squeezed out of the float.
Aflac expects continued growth ahead. The company’s CEO had this to say about expected results for the rest of 2015:
“With the first half of the year complete, I am pleased with the company’s results. Those results, combined with our outlook for the remainder of 2015, well-position us for another year of solid financial performance. These results have also given us the confidence to upwardly revise our target for 2015 operating earnings per diluted share to now be in the range of 4% to 7% on a currency neutral basis.”
As discussed above, Aflac expects to repurchase about 4% of shares outstanding in fiscal 2015. This means the company expects currency neutral operating income (before share repurchases) to grow 0% to 3% in fiscal 2015.
This level of growth is far below the company’s average operating income growth of 7.9% a year over the last decade.
Aflac’s growth has slowed in large part due to weakness in the Japanese economy. Japan is the most indebted ‘western’ country. Japan has a public debt-to-GDP ratio of 227%. Compare this to Greece’s debt to GDP ratio of ‘just’ 175%. For comparison, the United States has a debt to GDP ratio of 71%.
Massive debt and an expected negative population growth rate will likely doom the Japanese economy to several more decades of stagnation at best. Because Aflac generates 75% of its premium revenue in Japan, the country’s future is of importance to Aflac.
This does not, however, mean that Aflac will not reward shareholders with growth going forward. The company will likely not grow operating income near 8% a year over the next decade, growth of 3% to 6% is more likely. Still, with growth at these numbers combined with massive share repurchases and dividend payments of around 7% a year, Aflac offers investors total returns of 10% to 13% a year even with sluggish growth.
Aflac’s Valuation
Solid total returns bode well for shareholders. In addition, Aflac operates in perhaps the most stable industry in the world. The insurance industry is extremely slow changing. It is virtually inconceivable to think of any changes in technology that would make insurance obsolete. People will always have risks that they want to hedge – and insurance companies will fill this need (for a price).
The ‘icing on the cake’ for Aflac investors is the companies low valuation. Aflac is currently trading for a price-to-earnings ratio of just 10.8. Prior to 2009, Aflac traded for an average price-to-earnings ratio of around 19. The company appears deeply undervalued at current prices given its solid expected total returns.
The Bottom Line
Aflac is a high quality insurer. The company is the global leader in supplemental cancer insurance. The company has maintained after-tax operating margins over 10% since 2007. Aflac writes highly profitable policies.
When an insurance company is able to write profitable policies, it has a negative cost of capital. Aflac takes in money from customers in the form of premiums. It invests these premiums into (primarily) debt securities and earns interest on the ‘float’ – premiums paid that have not yet been paid out as benefits.
The company writes profitable insurance policies, so it pays nothing for its access to float. When an insurer can sustain writing profitable policies, it will be highly profitable. Aflac is among the most lucrative insurers around – and it is on sale for a price-to-earnings ratio of just 10.8.
Aflac’s combination of a solid dividend yield, excellent expected total returns, a long dividend history, and a low price-to-earnings ratio make the company a favorite of The 8 Rules of Dividend Investing. Aflac makes a compelling purchase for investors looking for additional exposure to the insurance industry.