2 Undervalued Financial Sector Stocks

Includes: AFL, RGA
by: Roger Choudhury

Instead of investing in the financial sector with these big banks, I found that the following 2 insurance companies offer good value.

Reinsurance Group of America (NYSE:RGA) is ranked #290 on the 2011 Fortune 500 list, and is among the largest global providers of life reinsurance, with subsidiary companies or offices in Australia, Barbados, Bermuda, Canada, China, France, Germany, Hong Kong, India, Ireland, Italy, Japan, Malaysia, Mexico, the Netherlands, New Zealand, Poland, South Africa, South Korea, Spain, Taiwan, the UK and the US. I believe that the company has plenty of room to grow in its Asia-Pacific division, which was only 11% of 2010 pretax earnings. Moreover, there should be steady demand for reinsurance products over the next few years even with stagnation of global economic growth. According to S&P, this is because excess underwriting capacity was likely wiped out by the losses incurred with the earthquake and tsunami in Japan.

Year-to-date, RGA is up by 11.45%, and in the past year, it has increased by 33.56%. RGA trades 7.3 times earnings, and safely at 0.9 times book value. In 2010, GAAP EPS grew by 38.56% to $7.69, and revenue grew by 16.91% to $8.262 B. In Q1 2011, operating EPS beat the Street estimate of $1.56 with $1.61, and was 28.8% higher than the figure in Q1 2010. Revenue also came in at $2.282 B (+8.66%). Going forward, in 2011, 11 analysts expect non-GAAP EPS to be $7.24 (+7.25%) alongside revenue of $8.8 B (+6.30%). This implies a reasonable forward 2011 P/E of 8.2.

Fundamentally, I believe that RGA should reach $67. This would imply a P/E of 9.25. The Reuters Research Average price target is $71.86. With shares currently trading below $60, this is a buy. RGA shares also have a dividend yield of 0.7%. The company is also rated (pdf) AA- by S&P, and A1 by Moody’s.

Aflac (NYSE:AFL) has been slaughtered this year by falling over 20% in share price, but it is still up by 8.57% over the trailing 12 months. The company beat Q1 2011 expectations of $1.52 for operating EPS with $1.63 (+15.60% from Q1 2010). Revenue did not meet analyst forecasts, but was up by 1.0% to $5.12 B. Aflac set aside $37 M in losses associated with the devastation in Japan. However, Aflac Japan also grew new premium sales by 12.6%. I also believe that the retiring baby boomer generation will provide stable growth opportunities in the US for the next several years. With improving global economic conditions over the next few years, there should be better investment opportunities for the company, yielding better-than-expected earnings.

In 2010, revenues grew by 13.58% to $20.732 B, and GAAP EPS jumped by 55.17% to $4.95. The EBT margin also improved to 17.29% from 12.24%. The company also has a low debt to equity ratio of 0.02. In 2011, the Street projects non-GAAP EPS to be $6.22 (+12.47%) alongside revenue of $22.7 B (+9.39%).

AFL trades with a compressed P/E of 10.1, and I believe that it should be closer to 11. I point to 2008 and 2009, where the P/E’s were 14.5 and 11.5, respectively. Also, in those years, revenue growth was in the 10%-14% range, which is similar to the expectation for this year. All in all, this would imply a price target of $68.50. In comparison, the Reuters Research Average price target is $63.89. AFL currently trades below $45, and I would recommend this as a buy for long-term investors. It is now a good time to buy on weakness.

AFL also has a healthy dividend yield of 2.6%. The company is #125 on the 2011 Fortune 500 list.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.