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Summary

  • The weakening yen has been masking the true financial performance of Aflac.
  • Diversification away from Japanese government debt into higher yielding instruments should begin to take place.
  • With continued sales growth in Japan and the U.S. along with a strong capital position, Aflac shares offer a solid value at the present price.

Aflac (NYSE:AFL) shareholders have recently been sharing the feelings of frustration so often demonstrated by the Aflac duck in his famous commercials. Shares have rebounded nicely from their 2011 lows, but haven't moved up as much as investors would like. As of early 2014, the shares are still below the pre-recession levels they were at 6 years ago. There are a few main issues which seem to be the main catalysts for keeping shares down:

Lack Of Geographic Diversity

Much of Aflac's growth strategy revolves around diversifying their product line, not diversifying the geographic area of their operations. Japan and the United States are the two countries Aflac operates in, with Japan accounting for about 75% of the business. Japan is a country which has been struggling financially for years, but that doesn't mean there aren't valid business opportunities still available.

It should come as no surprise that in a country where it is not uncommon to walk around with surgical masks to avoid disease, you can also find one of the largest health insurance markets in the world. Before the turn of the century, Aflac had a virtual monopoly in Japan. Deregulatory efforts around the turn of the century changed that. Right around that time is also when the Aflac duck was unveiled, a marketing campaign which kept awareness of the brand high. While now controlling around 70% of Japan's cancer insurance, Aflac Japan is still able to grow premiums and revenues nicely.

Year

2008

2009

2010

2011

2012

2013

Annualized Change

Premiums

¥1,101,233

¥1,137,958

¥1,181,389

¥1,245,361

¥1,368,480

¥1,461,132

5.8%

Total Revenue

¥1,314,733

¥1,353,746

¥1,399,570

¥1,463,141

¥1,600,292

¥1,725,216

5.6%

Aflac has also taken recent steps to solidify its position. Joining forces with the state-owned Japan Post, Aflac cancer insurance will now be sold at 20,000 post offices. Previously this was only done at 1,000.

Exposure To The Yen

This is often very misunderstood. Since the fall of 2012, the yen has weakened against dollar.

(click to enlarge)

While the yen does have an impact on reported EPS numbers, this is for all intents and purposes a reporting issue, not an economic issue. Except for a small number of transactions, yen is not converted into dollars in Aflac. Because of this, yen has the ability to mask Aflac's true financial performance.

The yen was 19.5% weaker in the 4th quarter of 2013 than in the 4th quarter of 2012. Operating earnings, Aflac's favored metric for judging financial performance, came in at $1.40 during the 4th quarter of 2013, down $.08 from 2012. However, the yen/dollar exchange rate took away a full $.18 from that number. When excluding the impact of the yen, operating earnings increased a healthy 6.8% for Aflac. Full-year 2013 numbers paint a similar picture. Excluding the impact of the yen, which weakened 18.2% against the dollar in 2013, operating earnings were up 5.2%. This beat the 5% target set by Aflac.

Exposure To Japanese Government Bonds

Japanese government bonds are among the lowest yielding bonds you can find. 43% of Aflac's portfolio, or $45 billion, is made up of Japanese debt. Another 27% is based in the United States and Canada, with the remainder spread throughout the world. Rather than turning away from Japanese government debt, Aflac's recent strategy has been to turn towards it. A few years ago, Aflac ran into some trouble due to its exposure to debt from the PIIG countries. Eric Kirsch was brought in from Goldman Sachs (NYSE:GS) to help oversee Aflac's investment portfolio. The initial strategy was to put more money into U.S. corporate debt hedged to yen. As interest rates moved up, that strategy switched to moving into Japanese government debt.

Part of the reason for the move was solvency metrics imposed on Aflac by Japanese regulators, which needed to be adhered to. Another part was the willingness to sit on the sidelines through some interest rate volatility, because Aflac was performing well on their financial metrics. After having an average new money yield of 2.47% in 2013, Aflac plans on increasing diversification in 2014. This could include everything from emerging-market debt to using hedge funds and private equity.

Conclusion

There are some other headwinds that Aflac is facing. The lack of adequate U.S. small business hiring at this time puts a limit on potential new policy holders. 90% of Aflac's U.S. accounts come from small business. Health care reform is also still being digested, which should lead to some deferred decisions surrounding healthcare-related coverage. Most of the concerns around Aflac seem to center around Japan. Save for some unlikely macroeconomic disaster in Japan, there really isn't anything too worrisome in my opinion.

Aflac has been taking advantage of the low share prices, and aggressively repurchased shares. 7.6 million shares at a cost of $502 million were repurchased during the 4th quarter. For the full year, 13.2 million shares at a cost of $800 million were repurchased. Under Aflac's current share repurchase authorization plan, 49.2 million more shares remain available to be repurchased. Aflac also sports a current yield of 2.3%.

Aflac's investment portfolio has been de-risked adequately since the European debt crisis, and appears to be excellently managed. The capital position is rock solid, and sales are anticipated to grow in both Japan and the U.S. in 2014. Risks that are professed to justify Aflac's low valuation appear to be either misunderstood, or more innocuous than claimed.

Source: Aflac's Japanese Risks Are Overstated