Life and health insurance provider Aflac (AFL) is less than a week away from releasing second quarter earnings. This is causing much excitement on the Street, as traders increasingly speculate about what issues management will address and the solutions offered for them. With analysts currently rating the stock near a "strong buy" and a multiple of only 6.2x forward earnings, investors can reap a hefty profit if Aflac is able to reassure the market that it has properly de-risked its portfolio.
Aflac has suffered from holding too many European-bank bonds and poorly structuring its $90B fixed-income portfolio. Since the start of 2008, shareholder value has fallen by 33.8%, nearly twice that lost by the S&P 500 (SPY) during the same time period. With a beta of 1.77, Aflac is a risky stock to hold amidst concerns over a double dip - even with its fair dividend yield of 2.9% and share repurchase program of roughly $400M for the year (~$340M for 2012). In my view, investors can expect drastic changes to the investing department come October 26.
In the past, management has said that it will cap outside managers at 10%. This is much too low and will likely be relaxed, as the firm possibly announces office openings in New York, and beyond. The environment is challenging for financials and changing the CIO to Eric Kirsch from Goldman Sachs (GS) remains only a step in the right direction. Higher variation in annuity DAC amortization is one more issue that will need to be addressed.
With that said, investors should never lose sight of the strong fundamentals that Aflac has. As I have expressed earlier, investors are vulnerable to exaggerating the risk inherent in financials. Aflac remains poised for better-than-expected growth in US and Japan with streamlined operations and a strong yen. At the second quarter earnings call, Chairman & CEO Dan Amos noted success abroad:
Aflac Japan generated strong financial results for both the second quarter and the first 6 months of the year. Revenue growth rose 3.7% for both the quarter and the first 6 months. In addition, our pretax margin continued to expand, resulting in solid earnings growth for the quarter and for the 6 months. We are particularly pleased with the continued sales momentum in the quarter. New annualized premium sales in yen exceeded our expectations and rose 6.6% to JPY 36.1 billion for the quarter, which was a record for the second quarter production.
For the first half of the year, total new sales rose 9.4%. These results are even more remarkable when you consider that Aflac Japan overcame challenges resulting from the most destructive and devastating natural disaster in Japan's history. With the expanding bank channel in mind, Aflac Japan has developed innovative products that align well with the product needs of banks. Bank sales continued a strong growth trend with sales of JPY 7.6 billion, which represents an increase of 95.6% over the second quarter of 2010. Sales through banks accounted for more than 21% of the total sales for the second quarter. I'll mention how we believe more banks, mega banks, in particular would step up their efforts in selling Aflac products, and that's exactly what we've been seeing.
Aflac Japan also has tremendous sustainability, as it is represented by more than 90% of Japanese banks. New product offerings, improved margins, and further expansion into Asia present incredible opportunities for the company.
As for Aflac US, during the second quarter, the segment experienced an impressive 5.9% growth in new annualized premiums. Guidance estimates for top-line growth in this segment range from flat to 5%. WAYS continues to be a tremendous value driver, growing by ~191% during the second quarter and maintaining margins double that of child endowment. WAYS offers holders a conversion to a fixed annuity that provides nursing care or medical coverage after a predetermined age is exceeded.
The consensus estimate for EPS is that it will grow by 14.6% to $6.34 in 2011 and then by 3.8% and 6.2% in the following two years. A strong foothold in the Japanese market will place Aflac in a commanding position when macro headwinds reside. For investors looking for international exposure and high risk-adjusted returns, the investment restructuring at Aflac is one event to follow.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.