Aflac: Another Dive to Come?

Mar.16.11 | About: Aflac Incorporated (AFL)
Aflac (NYSE:AFL) was down 3% and closed at 53.90 on Monday March 14, 2011. It was down as much as 10% in the morning Tuesday, trading in the US after the nuclear radiation concerns hit the markets globally. So is the stock cheap now or it is to slide further?
I am afraid the latter is to occur in the next few trading days. After three explosions and a fire at four nuclear power plants in the quake hit region, the Japanese market was down another 10% overnight on top of a 6% down the day before.
AFL is a life and health insurance company and operates in two segments: AFL Japan and AFL USA. Based on its latest financials, 75% of its revenue was generated from Japan and 25% from the US.
Management claimed last Friday after the quake and tsunami that its business in Japan will only suffer minor losses. This is probably a non-current evaluation. With the radiation leakage announced overnight standing at health-threatening level, however, it is hard to believe that the insurer will not see a major surge in claims in the next few quarters or years to come.
Interestingly, AFL is not only exposed to the quake and nuclear leakage in its Japanese business, its investment portfolio is also likely to be hit by the extended slide in the Japanese equity and debt markets and potential sovereign debt rating downgrade.

Its investment portfolio is heavily invested in Japanese debt or preferred stocks. Per its latest financials, out of its $86 billion total investments in fixed maturity and preferred securities, about $70 billion was invested in Japanese yen denominated securities.

This subjects its portfolio to the capital market's correction in Japan and globally. Insurance companies’ stock price usually trades closely to its book value. At a $50 stock price, its P/B is around 2.12x based on most recent quarterly book value per share of $23.54. Supposing its P/B ratio does not shrink given the current environment, a 2% hit at its investment portfolio would imply a stock price of $42.16.

Although some of the hits in investments may not show up on income statements initially but are recorded as unrealized losses on balance sheet, a deep and prolonged Japanese market correction would result in an Other-Than-Temporary -Impairment write-down eventually and the result would show up on earnings and EPS. The natural disaster and nuclear crisis would require the Japanese government increase spending significantly on an already debt laden government. A further rating downgrade is not unlikely following January’s downgrade by S&P of the country’s rating from AA to AA-.

If the nuclear leakage situation stays serious or even gets worse, the stock is set to take another dive when investors start to realize these facts related to the company’s business and investments.

Disclosure: I am short AFL.