Aflac And Visa: 2 Different Companies, But Both Can Be Bought By Dividend Growth Investors

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About: Aflac Incorporated (AFL), V
by: The Dividend Bro
Summary

We are underweight financials in the March to Freedom Fund, because companies in this sector were forced to cut their dividends during the last recession.

Aflac has increased its dividend for nearly four decades.  The stock offers an above market yield.

Visa has only been public since 2008, but the company has paid and raised its dividend every year since.

Aflac produced a new high for EPS in 2009, while Visa has increased EPS every year it has been public.

I find both to be slightly overvalued, but eligible for purchase due to their dividend growth streaks.

Most of the companies that my wife I want to own are already in the March to Freedom Fund so we are primarily focused on building out existing positions. One area where we are underweight compared to the market is financials.

Financials make up roughly 10% of our portfolio, compared to a nearly 14% weighting in the S&P 500. This has been done on purpose as financials were often the companies cutting dividends during the last recession. We are underweight this group of companies, particularly banks, in order to protect our portfolio from dividend cuts in this sector.

The only company in the financial sector that we own that cut its dividend during the last recession is JPMorgan (JPM). The other financial sector stocks that we own are Aflac (AFL), MasterCard (MA), which I discussed here, and Visa (V).

For this article, I will focus on Aflac and Visa, two companies that we haven't bought in quite some time. Both stocks have performed very well since the last time that we purchased them. Is now the right time to add to either name?

Company Background - Aflac

Aflac is a diversified insurance company that provides accident, short term disability and life insurance. The company is also the largest underwriter of cancer insurance in the world. Aflac receives the majority of revenues from Japan (~70%) with the U.S. (~30%) accounting for the remainder. The company has a market capitalization of $37 billion, with annual revenues of nearly $22 billion.

Recent Financial Results

Aflac released financial results for the fourth quarter and full year on 1/31/2019. All figures listed are in U.S. dollars. The company earned $1.02 per share during the fourth quarter, a 28% improvement from the previous year and $0.08 above consensus estimates. The company's revenue of $5.13 billion missed estimates by $225 million.

For the year, adjusted earnings-per-share increased more than 22% to $4.16. Revenue improved 0.4% to $21.8 billion.

Aflac Japan's had a 0.5% increase in total revenues during the fourth quarter. Premium income decreased 0.7% to $3.1 billion as certain policies became paid-up while new premium sales increased 2.2% or $214 million. Net investment income increased 7.7% to $602 million due to higher dollar-denominated floating rate assets. Cancer, medical and income support products improved 1%.

For the year, Aflac Japan experienced a 0.5% drop in total revenues. The company saw a 1.5% decline in premium income while net investment income was up 5.5%.

Total revenue for Aflac U.S. improved 2.4% to $1.6 billion during the fourth quarter. Premium income increased 2.7% to $1.4 billion. Net investment income inched higher by 0.5% to $183 million.

For the year, Aflac U.S. grew total revenues 2.4% to $6.4 billion. Premium income rose 2.6% to $5.7 billion.

Aflac expects adjusted earnings-per-share in the range of $4.10 to $4.30 for 2019. Achieving the midpoint of this guidance would represent a 1% increase from the previous year. The company expects a midpoint of share repurchase of $1.5 billion, representing 4% of the current market capitalization.

Insurance is a fairly stable business leading to predictable results. Listed below are Aflac's earnings-per-share from 2007 to 2010:

  • 2007 earnings-per-share: $1.64
  • 2008 earnings-per-share: $1.31 (20% decline)
  • 2009 earnings-per-share: $1.96 (50% increase)
  • 2010 earnings-per-share: $2.57 (31% increase)

Earnings-per-share suffered a steep drop in 2008, but Aflac rebounded and made a new high by the next year. Over the last decade, Aflac suffered a decline in earnings-per-share only twice, 2011 and 2014. In 2015, the company matched its earnings-per-share for the previous year. The ability to increase profitability almost every year has allowed Aflac to pay an increasing dividend for nearly four decades.

Dividend History

With 37 years of dividend growth, Aflac is a Dividend Aristocrat, an exclusive group of stocks with at least 25 years of dividend growth.

According to the U.S. Dividend Champions, the company has increased its dividend:

  • By an average of 9.6% per year over the last three years.
  • By an average of 7.9% per year over the past five years.
  • By an average of 8% per year over the past 10 years.

Aflac increased its dividend by 3.9% for the payment made 3/1/2019. The new annualized dividend is $1.08. Using the earnings-per-share midpoint of the company's guidance for 2019 of $4.20, this represents a payout ratio of just 26%. This is very much in line with Aflac's five and 10-year average payouts ratios of ~25%.

This low payout ratio means that the company will likely be able to continue to pay and raise its dividend even in the event of a prolonged recession

Some investors prefer to use free cash flow as a way to measure dividend safety as dividends are paid directly from cash flows. Aflac generated $6 billion in free cash flow and paid out $793 million in dividends in 2018 for a payout ratio of just 13%. Using free cash flow, the company's dividend looks even more secure than using earnings. The company is highly unlikely to cut its dividend due to cash flow.

Shares of Aflac yield 2.2% at the moment, slightly higher than the 1.9% yield of the S&P 500.

We last purchased Aflac on 3/24/2016 at the split adjusted price of $31.59. The stock has returned nearly 53% since this date. Are shares of the company trading at an attractive price today?

My Valuation for Aflac

If you're not familiar with how I value stocks, I take the current price and compare it to fair values and price targets from a number of different sources to see how over or undervalued shares are compared to these estimates. I also use the stock's expected earnings-per-share for the current year to determine a current price-to-earnings, or P/E, ratio. I then compare this to the stock's five-year average P/E from F.A.S.T. Graphs. I then take the average of these values to determine a price target.

For a company with more than 10 years of dividend growth, which Aflac has done, I am willing to pay 5% above what I consider fair value. I am willing to do this because these types of companies have managed to raise their dividends through a variety of different economic conditions. This type of strength is what I want in our portfolio in the event of a recession.

Current Yield

Years of Div Growth

5-Year Div Growth

2.20%

37

7.90%

Value Line Safety and Fin Strength

Current P/E

5 Year Avg P/E

2 / B++

11.7

10.5

CFRA 1 Yr Price Target

CFRA Fair Value

Morningstar Fair Value

$49

$47.29

N/A

Value Engine 1 Yr Price Target

Value Engine Fair Value

My Price Target

$45.83

$51.96

Under $50.75

Prior to making a purchase, I consult Value Line for their safety and financial strength ratings. I am looking for at least a 2 for safety and a B++ for financial strength. These ratings are a sign that the company's financials are solid.

Value Line gives Aflac a 2 for safety and a B++ for financial strength. Both ratings qualify the stock for purchase for us.

Using the 4/8/2019 closing price of $49.12 and the midpoint for adjusted earnings-per-share guidance for the year, Aflac's stock has a price-to-earnings ratio of 11.7. This is a 10.2% premium to the stock's five-year average price-to-earnings ratio of 10.5.

CFRA has a one-year-price target of $49, which is very close to the current share price. Their fair value estimate is $47.29, which means that the stock is 3.7% overvalued right now.

Morningstar doesn't provide a fair value estimate for Aflac at this time, so we will not be able to use this source.

Value Engine has a one-year price target of $45.83, which would be a 6.7% decline in price if the stock were to retreat to this level. Their fair value estimate is $51.96, which would result in a gain of 5.8% if the Aflac's stock were to reach this target.

Average these values out and I find fair value for Aflac to be $47.60. At the current price, the stock is 2.5% overvalued against my estimate, though this still qualifies the stock for purchase because of the company's dividend growth track record. Any price under $50.75 and I'd be a buyer of Aflac.

Company Back Ground - Visa

Another financial sector company that I hope to purchase this year is Visa. More digital payments around the world are done with a Visa branded debit or credit card than any other company. This gives Visa a market edge over its competitors because banks and merchants are likely to continue to accept the company's cards due to their widespread use. Visa has only been a publicly traded company since in 2008, but it has a market capitalization of nearly $347 billion. This makes the company one of the largest in the world. Visa has annual sales approaching $21 billion.

Recent Financial Results

Visa reported first quarter of fiscal 2019 on 1/30/2019. The company earned $1.30 per share, a 21% increase from the previous year and $0.05 above estimates. Revenue grew 13.3% to $5.5 billion, topping expectations by $92 million. A change in new revenue accounting standards due to tax reform passed at the end of 2017 contributed 1% to Visa's revenue growth during the quarter.

On a constant currency basis, payment volumes grew 11% on a constant currency basis and 7% on a reported basis. Payment volumes were higher by 10.6% in the U.S. Processed transactions grew 11% to $33.9 billion while cross-border volumes grew 7%. Total cards in use grew 4%.

These growth rates should be likely to continue as well as electronic payments worldwide have increased by 10% or so over the past few years. Growth of electronic payments are expected to increase at a CAGR of low double digits worldwide over the next few years, with at least 20% annual growth in emerging markets.

Client incentives were higher by 10% during the first quarter, but this was more than offset by gains in revenues. Client incentives as a percentage of gross revenues actually declined 50 bps to 20.9%. This is a very positive occurrence as it means that Visa is generating more revenue even as it has to spend more on client incentives.

Visa expects adjusted earnings-per-share to grow 15.4% to $5.32 in fiscal 2019.

Visa IPOed in the midst of a recession. Listed below are the company's earnings-per-share results from 2008 to 2011:

  • 2008 earnings-per-share: $0.56.
  • 2009 earnings-per-share: $0.73 (30% increase)
  • 2010 earnings-per-share: $0.98 (34% increase) 2011 earnings-per-share: $1.25 (28% increase)

Despite coming public during the last recession, Visa was able to post a high growth rate for earnings-per-share. Visa has increased its earnings-per-share every year since 2008. The ability to grow profitability every year is not easily attainable. This type of strength is what I want in our portfolio as earnings growth often leads to dividend growth.

Dividend History

Visa has paid a dividend every year it has been publicly traded. The company has now increased its dividend for 11 consecutive years, making Visa a Dividend Achiever.

According to the U.S. Dividend Champions, the company has increased its dividend:

  • By an average of 20.7% per year over the last three years.
  • By an average of 20.4% per year over the past five years.
  • By an average of 32.6% per year over the past 10 years.

Visa raised its dividend by 19.1% for the payment made on 12/4/2018. The most recent increase was very similar to the company's three and five-year averages. The annualized dividend is $1.00. Using the company's guidance for its midpoint for adjusted earnings-per-share of $5.32, the current payout ratio is 18.8%. This is slightly below the five-year average payout ratio of 19.4%, but above the 10-year average payout ratio of 16.9%.

Visa generated $3.3 billion from operating activities and spent $157 million on capital expenditures in the fourth quarter for free cash flow of approximately $3.1 billion. During this time, the company paid out $572 million in dividends for a free cash flow payout ratio of 18.2%.

Some investors may wish to go back further than a single quarter to determine if the company's dividend is safe when using free cash flow. For fiscal 2018, Visa generated $12.7 billion from operating activities and spent $718 million on capital expenditures for free cash flow of approximately $12 billion. The company paid out $1.9 billion in dividends over this same time period for a free cash flow payout ratio of 16%

Using either earnings or free cash flow, Visa has a very low dividend payout ratio.

While shares might yield just 0.63%, the company's dividend is well covered and is likely safe during the next recession. We own Visa not for its yield, but for its ability to grow earnings and dividends at a high level.

We last purchased Visa at $112.31 on 11/27/2017. Shares are up by more than 40% since then. After such a return, does the stock warrant purchasing here?

My Valuation for Visa

With more than a decade of dividend growth, I am willing to pay 5% above what I consider to be fair value for Visa.

Current Yield

Years of Div Growth

5-Year Div Growth

0.63%

11

20.40%

Value Line Safety and Fin Strength

Current P/E

5 Year Avg P/E

1 / A++

29.7

27.8

CFRA 1 Yr Price Target

CFRA Fair Value

Morningstar Fair Value

$166

$149.40

$136

Value Engine 1 Yr Price Target

Value Engine Fair Value

My Price Target

$170.56

$140.30

Under $160

Value Line gives Visa a 1 for safety and an A++ for financial strength. Both ratings are the highest a company can receive from Value Line in either category.

Using 4/8/2019 close price of $157.75 and the midpoint for adjusted earnings-per-share guidance for the year, Visa's stock has a price-to-earnings ratio of 29.7. This is a 6.3% premium to the stock's five-year average price-to-earnings ratio of 27.8.

CFRA has a one-year-price target of $166, which offers 5.2% upside from the current share price. Their fair value estimate is $149.4, which means that the stock is 5.3% overvalued at the moment.

Morningstar has a fair value estimate of $136, which would place the current price as 13.8% overvalued.

Value Engine has a one-year price target of $170.56, which would be a 8.1% increase if achieved. Their fair value estimate is $140.30, which would make the stock 11.1% overvalued currently.

Average these values out and I find fair value for Visa to be $152. At the current price, the stock is 3.8% overvalued against my estimate, though this still qualifies the stock for purchase because of the company's dividend growth track record. Under $160 and Visa is eligible for purchase under my investing rules.

Conclusion

We try to limit the risk in our portfolio, which is why we are underweight financials as a group. Aflac and Visa were two financials that were able to grow dividends during the last recession. Both companies have very low payout ratios using either earnings or free cash flow, which leaves them a large cushion to continue increase their dividends even if either metric were to decline.

This shows strength and that is what I want in our portfolio. While I consider both Aflac and Visa to be slightly overvalued at the moment, both are up for purchase because of their ability to grow dividends for long periods of time.

What is your opinion of these two names? Is there a different financial sector stock you are buying? Feel free to leave a comment below.

Disclosure: I am/we are long AFL, V, MA, JPM. 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.