Aflac: Still Cheap Despite The Recent Price Run-Up
Georgia based Aflac (AFL) is probably best known among the general public for the Aflac duck parading about television commercials. However, investors probably know Aflac just as well by its consistency towards rewarding shareholders. Over the past 31 years this supplemental insurer has not only paid a dividend but also increased each year; during the last decade these increases have come in at an average yearly rate of about 19%. Further, the company has continued to reduce share count - from about 531 million common shares outstanding in 1998 to today's number closer to 465 million. In just viewing these two metrics, it's clear that management has an eye towards the shareholder.
Aflac serves more than 50 million people worldwide - including a presence in all 50 United States and insuring approximately one out of every four Japanese households. In turn, the company's approach towards its business has allowed for a separation between Aflac and its peers. For one thing, Aflac is in the supplemental insurance business rather than the insurance business. Perhaps this is a slight distinction, but it is one that has allowed the company to flourish in an otherwise challenging marketplace. Supplemental insurance products tend to have higher margins than traditional products. This appears to stem from the idea that traditional insurance policies have a vast array of underlying data while disability information is less robust.
Morningstar analyst Vincent Lui does a great job of summing up how Aflac is different from its average competitor:
"Aflac sets itself apart from the typical life insurer in several ways. The company does not compete heavily in the commodified life insurance business; instead it has found a niche in selling supplemental coverage directly to employees at their worksites. The company does not maintain a large U.S. presence; it operates primarily in Japan, where the company generates nearly 80% of premiums and earnings. Japan's aging population, combined with declining birth rates, creates the perfect environment for the company's retirement and supplemental benefits. In our view, Aflac is one of the better-quality insurers in the industry. Aflac's unique business mix and low-cost distribution model have allowed the company to earn superior returns and garner a narrow economic moat."
Especially compelling in this sense is the description of the fundamental Aflac business model. Aflac works directly with large Japanese companies instead of agents to sell their product. Once an employee signs up, their premium is collected via payroll deduction - providing fewer costs for Aflac. Additionally, many of Aflac's policies are portable such that the employee is free to move them from employer to employer. Sequentially, Aflac's Japan customers tend to be highly loyal with a persistence rate of approximately 95%.
Yet none of that is to suggest that the company is without risks. For instance, a potential investor might believe that short-term issues related to the exchange rate, European investment exposure or the uncertainty of health care reform would negatively impact this business partnership. There's always a reason that a particular security carries risk. With that being stated, let's turn to the fundamental research tool of F.A.S.T. Graphs™ to review the past operating results of the company.
15 Years of Growth
Aflac has grown earnings (orange line) at a compound rate of 13.6% since 1999, resulting in a $30.5+ billion dollar market cap. In addition, Aflac's earnings have risen from $1.07 per share in 1999, to today's forecasted earnings per share of approximately $6.20 for 2013. Further, as described, Aflac has not only paid but also increased its dividend (pink line) for the last 31 years.
For a look at how the market has historically valued Aflac, see the relationship between the price (black line) and earnings of the company as seen on the Earnings and Price Correlated F.A.S.T. Graph below.
Here we see that Aflac's market price previously began to deviate from its justified earnings growth; starting to become largely undervalued during the most recent recession and not yet coming back to fair value. Today, Aflac appears undervalued in relation to both its historical earnings and relative valuation.
In tandem with the strong earnings growth, Aflac shareholders have enjoyed a compound annual return of 8.6% which lags the 13.6% growth rate in earnings per share due to overvaluation at the beginning of the period and undervaluation today. A hypothetical $10,000 investment in Aflac on 12/31/1998 would have grown to a total value of $34,453.50, without reinvesting dividends. Said differently, Aflac shareholders have enjoyed total returns that were roughly 2 times the value that would have been achieved by investing in the S&P 500 over the same time period. It's also interesting to note that an investor would have received approximately 1.7 times the amount of dividend income as the index as well.
But of course - as the saying goes - past performance does not guarantee future results. Thus, while a strong operating history provides a fundamental platform for evaluating a company, it does not by itself indicate a buy or sell decision. Instead an investor must have an understanding of the past while simultaneously thinking the investment through to its logical, if not understated, conclusion.
In the opening paragraphs a variety of operational positives and risks were described. It follows that the probabilities of these outcomes should be the guide for one's investment focus. Yet it is still useful to determine whether or not your predictions seem reasonable.
Twenty-one leading analysts reporting to Standard & Poor's Capital IQ come to a consensus 5-year annual estimated return growth rate for Aflac of 8%. In addition, Aflac is currently trading at a P/E of 10.6. If the earnings materialize as forecast, Aflac's valuation would be $132.65 at the end of 2018, which would be a 16.7% annualized rate of return including dividends. A graphical representation of this calculation can be seen in the Estimated Earnings and Return Calculator below.
Now, it's paramount to remember that this is simply a calculator. Specifically, the estimated total return is a default based on the consensus of the analysts following the stock. The consensus includes the long-term growth rate along with specific earnings estimates for the next two upcoming years. Further, the dividend payout ratio is presumed to stay the same and grow with earnings. Taken collectively, this graph provides a very strong baseline for how analysts are presently viewing this company. However, a F.A.S.T. Graphs' subscriber is also able to change these estimates to fit their own thesis or scenario analysis.
Since all investments potentially compete with all other investments, it is useful to compare investing in any prospective company to that of a comparable investment in low risk treasury bonds. Comparing an investment in Aflac to an equal investment in a 10-year treasury bond, illustrates that Aflac's expected earnings would be 4.9 times that of the 10-year T-Bond Interest. This comparison can be seen in the 10-year Earnings Yield Estimate table below.
Finally, it's important to underscore the idea that all companies derive their underlying value from the cash flows (earnings) that they are capable of generating for their owners. Therefore, it should be the expectation of a prudent investor that - in the long-run - the likely future earnings of a company justify the price you pay. Fundamentally, this means appropriately addressing these two questions: "in what should I invest?" and "at what time?" In viewing the past history and future prospects of Aflac we have learned that it appears to be a strong company with solid upcoming opportunities. However, as always, we recommend that the reader conduct his or her own thorough due diligence.
Disclosure: Long AFL at the time of writing.