AFLAC Inc. (NYSE:AFL), of the accident and healthcare insurance industry, has two firmly entrenched general public perceptions that are in contention with one another. The first perception is that AFL is a Dividend Aristocrat, with a 32-year-long history of raising dividends and a wide-competitive moat in both Japan and the United States. The second perception is that AFL's exposure to the Japanese market is a significant risk for the individual investor, and that this risk is the reason for what would seem to be a value-opportunity.
I have been following AFL since late 2011, and made my first purchase in December of that year, adding AFL as one of the first five holdings in my IRA. Since this time AFL has provided a return of just over 34%, including price appreciation and reinvested dividends, and while not the very best holding in the IRA (hard to beat Apple (NASDAQ:AAPL)) has been very solid and lived up to my original expectations.
The original metrics that AFL had to meet or exceed included a forward-looking PEG of 2 or less, a dividend yield of better than 3%, a compelling implied-run-room (based on the position of the price relative to the 52-week high) and a positive or better analyst rating while not having any glaring warning signs jumping out at me. That AFL was among the first five holdings added to my IRA signifies that it was very high on the list of passing stocks at that time and I am interested in determining whether AFL remains as highly compelling of a buy today as it did three years ago.
CURRENT METRIC SCREEN
AFL has had over 30% price appreciation since my original purchase in December 2011, and as a result the dividend yield-despite a recently announced 5.4% raise in line with recent revenue growth-as a consequence no longer would pass the 3% threshold of my purchase screen. Additionally, the listed PEG ratio via Yahoo Finance of 5.07, presents its own non-passing grade. This is an interesting point in and of itself, as I have been using Yahoo as my source for PEG since 2010 and this is based on the 5-year expected PEG-so thus forward looking, as opposed to others available which are derived from trailing numbers and thus not useful for forecasting future expectations. Another wrinkle, which is a topic I have given much thought to recently, is what contributor Sure Dividend has created referred to as "Modified PEG". Essentially this is a formula where the dividend yield is added to the growth-rate on the bottom of the PEG formula, so that the formula appears as below:
According to Sure Dividend's article on the topic, AFL has the lowest (and thus best) mPEG of the list of Divdend Aristocrats (however I disagree with their calculation as I have found the current mPEG to be 0.71 using their figures if I am doing it correctly, not 0.60 as stated in the linked article). I came upon my mPEG number of 0.73 for AFL by using the expected 10 year growth rate of 11.1 (based on the previous 10 years EPS growth rate), the current dividend yield of 2.52% and the estimated forward P/E ratio of 10. I am likely to continue to evaluate using both PEG and mPEG into the foreseeable future as I have been using PEG now for over 3 years, even at the theoretical detriment of having mostly focused myself on dividend yielding stocks-an inherent weakness in using PEG, which traditionally has made no accounting for dividends.
The last 52 weeks have not, on their own, been very kind on AFL-which could be attributed both to the continued ineffectiveness of Abenomics to cause the Japanese economy to turn the corner and break free of what is shaping up to be two successive "lost decades" as well as continued uncertainty regarding the effects the Affordable Care Act (Obamacare) will have. AFL is down 7.63% on the last 52 weeks, but sitting ~13% above the low (54.99) reached on October 16. My rule of thumb is that I add the percentage below the 52-week high (~5.86%) with the current dividend yield (2.52%), giving an implied-run-room of approximately 8.38% from current levels. The roughly 20% implied-run-room that would have been possible on October 16 may have provided the best entry point in the last year and the one most similar to where AFL sat in December 2011.
Back in 2011 I considered any mean analyst score of 3.0 or better to be passable but have since altered this to considering 2.5 or better to be passable, and 2.5-3.0 to be questionable to disqualifying and anything over 3.0 to be completely disqualified. Currently AFL sports a score of 2.6, which obviously would have been adequate in 2011 but at the present time would likely count it out for me. While Analysts are certainly going to be skeptical of AFL for the same reasons cited earlier-Japan and Obamacare-AFL has shown remarkable consistency over the last 8 quarters in meeting consensus earnings expectations (3 times) or beating them outright (5 times). The most recently reported quarter, Fiscal Quarter 3 2014, had a beat of 1.56 per share on consensus expectations of 1.43 per share, continuing 2014's trend of three significant beats in a row.
JAPAN AS A HEADWIND
Back on November 17, 2014, contributor Dana Blankenhorn said that AFL's problem was AFL is "Still A Proxy For Japan". Mr. Blankenhorn's premise is that AFL tends to mirror the rise and fall in Japan GDP, and with the trending downward Japanese economy, AFL is certain to face problems stemming from the 75% of their earnings originating in this market. To quote from Mr. Blankenhorn's conclusion:
So if Japan is going south and the medical coverage market is going nowhere, that spells trouble for AFL stock, at least until it can develop, and market, new products that become real growth catalysts.
On the Q3 Earnings Call, however, some light was shed on good news on this front. AFL announced that they had been able to expand their retail marketing scheme with Japan Post, increasing the number of postal outlets selling cancer products in Japan from 3,000 to 10,000 effective October 1, 2014, and provided an estimate of this number doubling by the end of 2015. Two new cancer products were also announced for Japan as well.
A MIRAGE IN THE DESERT?
If I were trying to decide today whether to pull the trigger or not on AFL, using my previous metric based approach and the potential issues related to AFL deriving 75% of their earnings from Japan, I may pass and wait for another opportunity such as what appeared in Mid-October 2014 to reappear. Based on some new tools in my toolbox, however, I must pause for further consideration.
I have recently began using a few different methods projecting expected values for shares, both in the current and future time-frames. The quickest and easiest is via Guru Focus, where there is a Discounted Cash Flow and Reverse Discounted Cash Flow calculator available. AFL sports a very comfortable margin of safety, whether choosing to include Tangible Book Value of 39.63 (56% / 140.88) or not (39% / 101.25) in calculating fair value. Using the Reverse DCF calculator, which shows the annual growth rate necessary to justify the current share price, AFL has an indicated necessary growth rate of 3.49%, well below the historic 10-year annual growth rate of 11.1%. Using the R-DCF and having chosen to factor the Tangible Book Value into the share price results in an indicated necessary growth rate of -14%, which is just silly.
Also I have recently acquired an Intrinsic Value Calculator that uses Total Cash Flow, long-term growth rate, BETA, and the number of shares to calculate target share price. Using the most recently available information for AFL the calculator has projected an intrinsic share value of 261.72, which is more than a 300% gain from the December 29 close of 62 per share. I have been testing this calculator for a few months now-and if I had only ever used it on AFL, I would assume is was broken or something and maybe never used it again. Instead I have been using it for a few months now and am constantly surprised/impressed when it spits out numbers that are very close to those which I have derived via other means-which is the main reason this 261.72 number gives me reason for pause (much less mention it here). As a further test of the tool when applied to AFL I plugged the negative growth rate of -14% into the tool (rather than historical 10-year growth rate of 11.1%) and the intrinsic share value provided was 79.13, a 12.7% increase from the December 29 close.
While I may not have been interested in purchasing AFL at the present time based on my most often used metric screen, the DCF and IVC valuation methods give further weight to the argument that AFL may indeed by very undervalued by the market at this time. Even if we were to completely ignore the high value of 261.72, the low/med/high numbers provided by the IVC and DCF are very attainable if many things went right and the market continued the current bull run. I am very comfortable in saying that the consensus target price of 66.25 will be taken out easily and soon if AFL continues its recent streak of earnings beats, and I have my eye in the mid-70's by this time next year.
Disclosure: The author is long AFL.
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.