Aflac: A Dividend Champion Gift For The Patient Investor

Summary

• Aflac's stock has been bruised and battered by plummeting interest rates and treasury yields.
• Aflac has a long history of growing its dividend in a variety of economic environments. The conservative nature in which Aflac is run gives us reassurance of a safe dividend.
• The stock is attractively valued, giving investors long-term upside for when rates and yields eventually move higher again.

Supplemental insurance provider and dividend champion Aflac Incorporated (NYSE:AFL) has been hit especially hard by the recent sell-off in the overall stock market. The price of shares has contracted a whopping 30% in just the last month. This movement has presented a buying opportunity in our view. The company remains stable financially, and insurance is a product/service that will see continued demand over the long term. The stock's valuation now represents a deep discount to historical norms. Investors need to heed caution as interest rates continue to drop (reducing profitability of financial institutions and insurance companies), but long-term upside will be realized as rates eventually rebound in the years ahead.

Note: This article is an update on Aflac's dividend and valuation. A complete profile of the company can be found HERE.

Dramatic Negative Price Movement

As we can see, shares had remained relatively neutral for most of the past six months. However, the negative market movement of the past few weeks has drastically impacted shares, pushing the stock to dramatic, new 52-week lows of just over $36 per share. The stock currently trades in that neighborhood at just over $37 per share. The movement represents a rough 30% decline in just a few weeks.

source: Ycharts

Why Has The Stock Declined?

Aside from the obvious downward pressure of the broader market, Aflac has been pressured from an investment climate that features lower and lower interest rates and yields.

There are two primary functions of how insurance companies make money. These companies sell policies to consumers who pay premiums in exchange for policy coverage. These premiums are then pooled and invested to generate investment income. How effectively the insurance business is able to balance the spread between inflow (premiums and investment income) versus outflow (claims paid) largely dictates the overall success of the insurance company.

Insurance companies such as Aflac have to leave a significant margin of safety in their investment practices to make sure that the business maintains enough liquidity to cover the vast range of scenarios that could impact the amount of policy claims. This points companies such as Aflac towards conservative investment assets such as bonds, real estate loans, and treasury notes. We can see that the vast majority of Aflac's allocations are in "fixed maturities securities". This category would cover stable investments such as high-quality bonds and treasury notes.

source: Aflac Incorporated

While rates have gyrated a bit over much of the past decade, they have recently plummeted to the lowest levels on record. This is a significant headwind for companies such as Aflac, because it pressures their profitability. Aflac may have to combat this by raising the price of premiums to its customer base.

source: Ycharts

The Dividend Is Appealing - And Safe

These headwinds have pressured the share price - making the dividend's yield grow larger as a result. The current yield of 2.89% is roughly the third highest it has been over the past decade. It's significantly higher than the stock's 10-year median dividend yield of 2.34%. We often compare dividend yields with treasury notes to gauge how strong of an income generating asset a given stock is, but that hurdle is obviously quite low given the state of treasury yields today.

source: Ycharts

Despite the dividend yield being abnormally high, we see safety in the dividend. Aflac has raised its dividend each year for the past 38 years. This growth streak of nearly four decades means that the dividend has grown through the financial crisis, and other recessionary events over the years.

While the company faces historic pressure from lower interest rates/yields, the dividend consumes just 23% of earnings. The company actually spends more cash each year on stock buybacks (more than $1 billion annually). It's certainly possible that Aflac may have to readjust its 2020 guided earnings at some point, but the type of systemic collapse needed to disrupt Aflac's business enough to cut its payout just isn't very likely in our view. With rates so low, we feel that the worst is upon us from Aflac's point of view.

Valuation Is Attractive

This potential inflection point is why we find the stock attractive today. As we mentioned earlier, the stock's current price is a new 52-week low. It's the lowest share price that Aflac has traded at since mid-2017 (split adjusted).

If we take the company's current 2020 guidance of between $4.32 and $4.52 (a midpoint of $4.42), the share price produces an earnings multiple of approximately 8.6X. This is a significant discount (20%) to Aflac's 10-year median PE ratio of 10.7X.

Additionally, Aflac's stock is now trading at less than its book value with a price to book ratio of 0.946X. This is easily its lowest ratio over the past 10 years.

source: Ycharts

Are there risks? Sure there are. The business model will be pressured by lower rates/yields, and management could reduce its earnings guidance as the year progresses. But given how Aflac is conservatively managed and its long track record of dividend growth in the face of various economic scenarios, buying into a well-run company in the face of its challenges can be a rewarding long term decision. We find the risk/reward ratio to be favorable for a long-term holding period at these levels.

Wrapping Up

Continued broader market selling - or further dropping of interest rates could both push Aflac shares lower from here still. However, investors looking for an attractively priced company with a long track record of steady success can benefit from a rock solid dividend and appealing valuation thanks to these historically low rates/yields. As rates/yields eventually rebound, Aflac will likely respond with an appreciating share price. Until then, investors can enjoy a steadily increasing dividend payout.

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