Aflac's False Currency Woes Create Undervaluation And Opportunity

| About: Aflac Incorporated (AFL)

The market has been on a tear this year with major indexes hitting all time highs. In this environment, it becomes increasingly difficult to find value with a margin of safety. Many dividend growth stocks are reaching valuations that make it difficult for value minded investors to pull the trigger.

Aflac (NYSE:AFL) is a healthy company with strong management and leadership yet is currently undervalued due to the exaggeration of the effect currency exchanges have on Aflac's operating results and bottom line. This problem arose as Japan's currency started to tank after many years of continued growth in strength. Despite currency valuation changes, the company's fundamentals and management structure has not changed. Despite a turbulent economic environment, Aflac's business is healthy. This is due in large part to the fact that except for a limited number of transactions, which includes the Aflac Japan dollar investment program, the company does not actually convert yen into dollars. As a result, Aflac views foreign currency as a financial reporting issue and not as an economic event for the company or its shareholders. These are the types of events that allow us to purchase high quality securities at bargain prices. AFL is a dividend growth investor's dream as they have raised their dividend for 30 straight years. By the "Father of investing" Benjamin Graham's number, AFL is undervalued by 23.2%. Aflac, as of the close of the market Friday, was trading at $53.20, an 8.72 P/E with a 2.72% Dividend yield. The EPS payout is a healthy 22.95%.

Aflac Inc. is a general business holding company and acts as a management company. The company sells supplemental health and life insurance in the United States and Japan.

QUACK FACTS courtesy of Aflac:

  • Aflac is a Fortune 500 company.

  • Aflac's assets at year-end 2012 totaled more than $118 billion with annual revenues of more than $25.4 billion.

  • Aflac is the number one insurance company in terms of individual insurance policies in force in Japan, insuring approximately one out of every four Japanese households.

  • Aflac has a presence in all 50 United States, and in Puerto Rico and the Virgin Islands.

  • Aflac Incorporated, its employees, and its independent sales associates have contributed more than $79 million to the Aflac Cancer and Blood Disorder Center of Children's Healthcare of Atlanta.

  • Aflac is committed to a healthy environment and sustainable business practices.

Currency Issues:

Many doubters of Aflac reference the fact that the Japanese currency is being devalued by BOJ action and therefore the company's financials are hurt due to unfavorable currency exchanges. Management however has stated repeatedly in the past earnings calls that this is not something to be worried about.

Management Answers to Currency Questions at Q1 Earnings Call:

Chris Giovanni - Goldman Sachs

I guess the first question obviously with currency and the impact of the Yen moving all over the place. Have you guys given consideration to hedging the earnings of the company and just the thought process around that?

Ken Janke

Chris, this is Ken. Let me start with that. This has been an issue as long as we've been in Japan as Japan has grown to be a larger portion of our business that obviously has affected the sensitivity of earnings to currency changes. But the one thing that I would remind you is that there is a distinct difference between foreign currency transactions and foreign currency translation. We are certainly interested as Robin indicated in hedging economic events like capital being remitted from Japan to the United States. But we don't think it makes sense to enter into an economic contract to hedge a financial reporting event. Largely Japan is a yen denominated entity that's self-funded. We collect premiums in Yen. We pay benefits and expenses in Yen. We back our Yen liabilities with Yen assets, but to the degree that this year's Yen rate differs from last year's influences how those Yen get reported in dollars. So again when we think about hedging, we're really focused on the economics of the business as opposed to financial reporting of the business.

Growth and Value creation:

Management conceded at the end of 2012 that growth in 2013 would be slow due to the great growth seen in the last three years however it would still be stagnant to 5%. In light of the slower growth, management has been focused of providing shareholders value through other means. For the outlook for 2013 Dan Amos said, "Understand, unless an extraordinary event occurs, we intend to purchase a minimum of $400 million of our shares this year." The company said the buyback could be up to $600 million.

Reading the Earnings call from Q1 2013 we see that AFL is on track to reach their goals and possibly exceed growth estimates. For the first quarter of 2013, new annualized premium sales were up 2.6% to ¥53.8 billion. Revenues grew 9.7% and pre tax earnings were up 10.7% for the quarter. With respect to total third sector products, combined cancer and medical insurance sales, were down 7.1% for the quarter which was inline with expectations. Management has said however that they are focused on remaining the leading provider of third sector products and will be more focused now that the first sector rerating has been complete. As management expected, Aflac U.S new annualized premium sales were down 5.2% for the quarter.

Dividend Growth and Share Repurchasing:

For 2013, management stated in the Q1 earnings call that "Our objective is to grow the dividend at a rate that is inline with earnings per share growth before the impact of the yen. We have a lot of flexibility at the parent company in terms of liquidity. Given the liquidity and the strength of our capital ratios, we plan to purchase $400 million to $600 million of our shares in 2013. We are off to a great a start with our share repurchase plans for the year. In the first quarter we purchased approximately 3 million shares or about $150 million. I think this shows that we are even more comfortable with this rate. Additionally, we expect to accelerate our share repurchase in 2014."

This graph here shows the share repurchasing from 2002-2011 in which management decreased the number of shares outstanding every year except for one.

Figures in USD. Fiscal year ends in December











Shares Outstanding











Stock Bought Back











Source here

As we can see, Aflac's management has proven itself to be committed to stock repurchasing and returning value to the shareholder over long periods of time.

Management in Aflac believes that an analysis of operating earnings, a non-GAAP financial measure, is vitally important to an understanding of the company's underlying profitability drivers. Aflac defines operating earnings as the profits derived from operations before realized investment gains and losses from securities transactions, impairments, and derivative and hedging activities, as well as non recurring items.

We can then look at how AFL does on an operating earnings basis by utilizing Chuck Carnevale's F.A.S.T. graphs.

The green shaded area represents the operating earnings growth rate which is 13.7% for the last 15 years that this graph represents. The orange line represents the GDF-PEG valuation line and the black line represents the price. As we can see, based on the historic valuation level by operating earnings (the way management says you should evaluate the company), AFL is considerable undervalued.

Forward looking for 2013 after Q1:

2013 guidance of 4% to 7% increase in operating earnings per share, excluding the impact of currency. This range reflects the impact of investing significant cash flows at historically low interest rates. I would also remind you that 2012 earnings were better than expected. Although the Yen is significantly weaker to the dollar, the fundamentals of the business and operations are strong.

Aflac passes many screening processes such as the Graham number, Chuck Carnevale's F.A.S.T. Graphs as well as management's share repurchasing and commitment to shareholder value. I believe that at these prices, Aflac is undervalued with a nice margin of safety. A great opportunity for the value investor.

Disclosure: I am long AFL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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