Why Aflac Is So Cheap

Aug.25.14 | About: Aflac Incorporated (AFL)

Summary

Investors wonder why Aflac, a dividend aristocrat, is trading at a P/E of 10, while the S&P is trading at a P/E of 17.

Aflac has already sold insurance to 1/4th of Japanese households, so it is hard to sustain its past growth rate.

Investors are also cautious to see that 40% of the company's assets have been invested in Japanese government bonds. Japan has the heaviest debt load in the world (238% GDP).

Nevertheless, part of the low P/E is due to the last financial crisis, which made investors fearful of financial companies. Astute investors should utilize this situation.

Many investors wonder how Aflac (NYSE:AFL) can trade at only 10 times its earnings per share (NYSEARCA:EPS), particularly now that the market is at its all-time high, trading at 17 times this year's earnings. To make things even more surprising, premium companies like Aflac, which has raised its dividend for 31 consecutive years, usually trade at a premium. At least this is what experience has shown with stalwarts such as Coca-Cola (NYSE:KO) and Procter & Gamble (NYSE:PG).

First of all, investors have become more conservative after the great financial crisis 6 years ago, and now tend to assign a lower P/E to financial companies than they used to before the crisis. This is actually observed after any crisis of a specific sector, and results in the emergence of bargain stock prices in that sector as long as the companies rebound from the crisis.

Besides the low P/E of the financial sector, a major point of concern for Aflac is the fact that it has already sold an insurance program to 1/4th of Japanese households. As Japan represents 77% of its total sales, one can understand that it is difficult to grow from this point. Even worse, the company did not manage to grow in the US either in the first half of the year. I am surprised that some investors do not realize how limiting the previous expansion is for a stock. For instance, I see some authors praising a stock (e.g. Coca-Cola) because the company sells its product in 200 countries. Well, this shows excellent past performance, but there is no room for further growth then. In reference to Aflac, I am not saying that it cannot grow. However, it is evident that growth will probably be hard and slow from now on.

Another reason for concern is that 40% of the company's assets are Japanese government bonds. As Japan carries the heaviest debt burden relative to its GDP (238%), it is reasonable to feel cautious about this risky allocation of the assets.

Apart from the above factors, the nuclear accident in Fukushima should also cause some concern. Actually, such accidents should be the worst nightmare for insurance companies that mainly rely on selling health insurance packages. The market was indeed scared on the news of the accident, and sent the stock of Aflac 20% down in about 3 months. Although everyone has forgotten about that accident, it is a sure thing that numerous cancer incidents will show up in Japan in the next 2 decades in the aftermath of that accident.

Finally, another headwind for the results of Aflac has been the falling exchange rate of the yen vs. the dollar. As 77% of the business of the company is in yen, the falling yen results in lower earnings in dollars. Even worse, the dollar is expected to strengthen further, thanks to the end of quantitative easing (QE). However, the management of Aflac has emphasized that it does not convert yen into dollars in reality, and hence, its shareholders should not worry about this exchange rate. The conversion of the results into dollars is performed only for accounting purpose.

To sum up, unfortunately for bargain hunters, there are always good reasons behind any bargain stock price. This holds true in the case of Aflac as well. Whether the above concerns fully justify the discount remains to be seen. On one hand, the management of the company has proved its excellence, and this is a critical factor to consider before buying any stock. On the other hand, one might find an even better entry point if a general market correction materializes, now that QE is coming to its end.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.