Aflac's Q1 2018: I'm Sleeping Well With My Shares

Summary

• Last week, Aflac Inc. reported its results for the first quarter of 2018.
• As expected, the net profit grew, boosted by the lower corporate tax in the U.S. and a favorable yen/dollar exchange rate.
• However, these effects should not overshadow the slight improvement in the margins.
• With a well-monitored business, an increasing dividend and an active share repurchase program, I am keeping my shares and sleeping well.

Executive Summary

Last week, Aflac Inc. (NYSE:AFL), a general business holding company operating in Japan and the United States which sells voluntary supplemental insurance products, shared its results for the first quarter of 2018. Its net income grew by 21% to $717 million, benefiting from the lower tax rate in the U.S., revenue growth and a slight improvement in margins both in the U.S. and Japan. As a shareholder of the company, I am confident about the ability of the insurer to reach its 2018 targets and sleep well with my shares accordingly.

Revenues Boosted By A Favorable Yen/USD Exchange Rate

Being a market leader can become problematic when a company wants to grow its business. When you are a giant like Aflac, investors cannot expect 10% growth per year. However, the increase in premiums could be in the range of 2-5%.

In Q1 2018, net earned premiums increased by 2.3% to $4.7 billion. The growth in premium revenues was mainly related to the favorable yen/dollar exchange rate. Excluding the foreign exchange rate, premiums in Japan declined by 2.6% to ¥353 billion ($3.3 billion).

As during 2017, the Japanese subsidiary continued to focus on cancer products and medical products during the first quarter of 2018, and reduced its exposure to other products (e.g., child endowment products and life insurance products). However, the commercial trend remains negative for all the segments, as the new annualized premium sales declined everywhere (-4.5% from cancer products and -20% from the medical segment on a YoY basis).

Fortunately, U.S. sales grew and offset the premium decline observed in Japan partially. In the first quarter, Aflac's U.S. premium income increased 2.7% to $1.4 billion. Furthermore, the new annualized premium sales and annualized in-force premiums grew by 0.6% and 2.7% respectively.

On the segment side, the relative size of hospital indemnity and critical care premium sales increased from Q1 2017 to Q1 2018. On a full-year view, the company expects to generate premium growth in the range of 2-3% for 2018 for the U.S branch.

Regarding total revenues, the breakdown between the U.S and Japan remained stable, mainly due to the favorable yen/dollar exchange rate during the first quarter of 2018.

Source: Aflac’s Q1 2017 Report

On the investment income side, revenues grew by 5.4% to $837 million, mainly due to higher-yielding U.S. dollar investments.

Still A Great Operating Performance

Aflac is known for having a solid track record regarding its operating performance. With a 6-year average net combined ratio of 93.5%, the insurer vigorously monitors its underwriting performance, which is mainly driven by a low combined ratio (around 67%) and a disciplined expense ratio (about 26%).

During the first quarter of 2018, the company succeeded in maintaining its level margins in the U.S. and Japan. The combined ratio was 92% in Q1 2018, or a 70 bps improvement on a YoY basis.

Source: Aflac’s Q1 2017 Report and Annual Reports

The margin improvement was mainly driven by a lower claims cost level than in Q1 2017. The net loss ratio improved by 1.6 percentage points to 63.8%.

Source: Aflac’s Q1 2017 Report and Annual Reports

The claims situation improvement was partially offset by the growth in expense ratio, which worsened by 0.9 percentage point to 28.2%

Source: Aflac’s Q1 2017 Report and Annual Reports

The increase in expense ratio was mainly driven by the Japan branch conversion costs recorded for the quarter and the investment made in the U.S. to improve the IT platforms.

The expense ratio is lower in Japan than in the U.S. due to Aflac's leading position and multiple distribution channels. However, the company's U.S. branch remains more profitable than Aflac Japan.

Source: Aflac’s Q1 2017 Report

According to company management, thanks to the lower tax rate in the U.S., Aflac intends to invest $250 million over the next 3-5 years in the U.S. subsidiary. Then, the contribution from the American entity should increase over the years, even if the Japanese subsidiary remains the largest one.

Don’t Be Fooled By The Stock Split: The Dividend Is Still There And Will Grow

With the stock split, the absolute dividend amount seems to have decreased, as shareholders would have received $0.26 per share per quarter.

Source: Aflac’s Q1 2018 Report and Annual Reports

Don’t be fooled by the declared amount; shareholders will receive the expected level of money before the stock split, i.e., $0.52 per share. Hence, Aflac remains a Dividend Aristocrat.

Source: Internal

Furthermore, the company has continued to repurchase its shares during the first quarter of 2018. In the first quarter, Aflac repurchased 6.6 million, or $296 million worth of its common shares. At the end of March, it had 91.4 million shares available for purchase under its share repurchase authorizations.

As for the dividend amount, the outstanding shares seem to have increased, but this is related to the stock split.

Source: Aflac’s Q1 2018 Report and Annual Reports

Adjusted to the stock split, the outstanding shares declined slightly by 0.7%.

Source: Internal

Even after the stock split, I will be more than surprised if the company changes its capital redistribution policy; hence, the shares will be repurchased and the dividend will increase over the years.

Conclusion

The results of the first quarter of 2018 were as I had anticipated, i.e., good commercial development in the U.S. and a premium slowdown in Japan. However, Aflac is an insurer, hence the primary goal of the company remains to maintain its underwriting margin at around 8% (i.e., a combined ratio of approximately 92%). On this count, Aflac did not disappoint me. Furthermore, the company continued to repurchase its shares actively. With a growing dividend, a predictable business (with some threats in Japan due to the exchange rate and the drop in premium revenues), I can sleep well. That’s what I do by keeping my Aflac shares.

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Analyst’s Disclosure: I am/we are long AFL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.