Published by Nick McCullum on July 19th, 2017
The Dividend Aristocrats are some of the highest quality businesses around.
With 25+ years of consecutive dividend increases, these companies have proven both their ability and willingness to return cash to shareholders. You can see the list of all 51 Dividend Aristocrats here.
The long dividend histories of the Dividend Aristocrats is indicative of strong, enduring competitive advantages.
With that said, not every Dividend Aristocrat makes a compelling investment at any given time. Some will be overvalued while others are undervalued.
Right now, Aflac (AFL) is the Dividend Aristocrat with the cheapest valuation based on a weighted index of price-to-earnings, price-to-book, and price-to-cash-flow ratios.
The company may be a compelling buy at today’s prices.
This article will analyze the investment prospects of Aflac to determine whether this cheap Dividend Aristocrat is a screaming buy or a value trap.
Aflac Incorporated is the world’s largest provider of supplemental insurance.
The company is also engaged in the underwriting of other types of insurance, including health, Medicare supplement, life, accident, and long-term convalescent care insurance.
Aflac was founded in 1955, has increased its dividend for 33 consecutive years, and has a current market capitalization of $30.8 billion.
To understand Aflac’s business model, it is very important to understand what supplemental insurance really is.
Supplemental insurance offers protection to policyholders from certain qualifying events, including cancer diagnosis, disabilities that keep the insured from working, or other particular medical events.
Once a qualifying event has been declared by the policyholder, Aflac pays cash benefits directly to the insured. These cash benefits are fixed and do not increase with inflation over time.
Aflac provides supplemental insurance in two distinct geographies:
- Aflac U.S.
- Aflac Japan
The company’ product offering differs slightly between its two operating geographies (although both specialize in supplemental insurance).
Aflac U.S. also offers cancer, accident, and short-term disability, along with dental, vision, and various forms of life insurance.
In addition to supplemental insurance, Aflac Japan also offers life insurance products and two forms of savings plans.
Because of Aflac’s significant presence in Japan, the company is heavily exposed to the Yen/Dollar exchange rate.
Since ~2011, the Yen has weakened considerably versus the U.S. dollar, which means that Aflac’s Japanese earnings become less valuable when swapped back to USD for reporting purposes.
Source: Aflac Company Fact Sheet
This has contributed to weaker-than-desired earnings growth for Aflac.
However, mean reversion is a powerful trend in the financial markets. The Yen is currently much weaker relative to the U.S. dollar than its 10-year average.
If the Yen reverts to its 10-year average, this will provide a tremendous earnings tailwind for Aflac.
Current Events & Growth Prospects
Aflac’s first quarter earnings release was weaker than expected. Earnings-per-share declined by 3.5% over the same period a year ago.
Reasons for the company’s struggles include the weak Yen as well as persistently low interest rates, particularly in Japan. This makes it difficult for Aflac to invest its insurance float at attractive rates of return without assuming undue risk.
On a segmented basis, fundamental performance was better than the bottom line would suggest.
Aflac U.S. reported new sales of $333 million, a 1.5% increase over the $328 million reported in last year’s quarter.
Aflac Japan’s performance stood out, as the company’s third sector sales increased by 7.1%.
All said, Aflac’s poor bottom line performance was primarily driven by factors outside of its control, including foreign exchange fluctuations and low interest rates. The company continues to be an attractive, well-run enterprise for buy-and-hold investors.
Looking ahead, Aflac’s growth will be driven by the increasing need for supplemental insurance.
In developed economies around the world, populations are aging and birthrates are declining. Since Aflac’s customers are primarily older individuals, this provides a long-term secular tailwind for this insurance company.
Competitive Advantage & Recession Performance
Aflac’s primary competitive advantage comes from its industry leadership in the supplemental insurance industry.
Thanks to its entrenched position and strong relationship with insurance agents and marketing agencies, consumers are highly likely to purchase insurance from Aflac.
Aflac also performs quite well during recessions.
Aflac’s recession resiliency can be seen by its performance during the global financial crisis of 2007-2009:
- 2007 adjusted earnings-per-share: $3.27
- 2008 adjusted earnings-per-share: $2.62 (19.9% decrease)
- 2009 adjusted earnings-per-share: $3.91 (49.2% increase)
- 2010 adjusted earnings-per-share: $5.13 (31.2% increase)
Aflac’s earnings-per-share declined by ~20% during the Great Recession but the company reported a new record high in per-share profitability in the subsequent year.
The company should perform well in any future recessions, as it has plenty of liquidity on hand – $4.2 billion of cash and equivalents at the end of the most recent quarter, which amounts to ~13.7% of its current market capitalization.
Valuation & Expected Total Returns
As an insurance company, Aflac’s valuation is best measured using the price-to-book ratio (instead of the more typical price-to-earnings ratio).
Aflac’s most recent quarterly earnings release reported book value per common share of $51.11.
Based on its current market value of $77.75, the company is trading at a price-to-book value of 1.5. The following diagram compares this figure to its long-term average.
Source: Value Line
Aflac’s current price-to-book value of 1.5 is below its long-term average of ~2.2. Right now is a historically opportune time to buy this stock.
While the valuation of insurance companies is typically done using the price-to-book ratio, a price-to-earnings valuation may also be appropriate for Aflac because of its generally stable earnings-per-share.
In fiscal 2016, Aflac reported adjusted earnings-per-share of $6.79.
Using this earnings figure, the company’s current stock price of $77.75 is trading at a price-to-earnings ratio of 11.5.
We can also value the company based on its 2017 expected earnings-per-share.
Aflac is expecting operational earnings-per-share of $6.40-$6.65 for the full-year of 2017 before accounting for the impact of currency fluctuations.
Using this the midpoint of this earnings guidance ($6.525) and the company’s current stock price of $77.75 gives a forward-price-to-earnings ratio of 11.9.
The following diagram compares Aflac’s current price-to-earnings ratio (using both 2016 and 2017 earnings) to its long-term historical average.
Source: Value Line
Just as with its price-to-book ratio, Aflac’s price-to-earnings ratio is below its long-term average (although slightly elevated from recent levels).
Thus, regardless of which valuation metric you prefer, Aflac’s valuation is the most compelling reason to buy this stock today.
Investor return will also be boosted by dividend payments and growth in the company’s intrinsic value per share.
Aflac currently pays a quarterly dividend of $0.43 per share which yields 2.2% on the company’s current stock price of $77.75.
While the company’s dividend yield is not spectacularly high, investors should take comfort in the insurer’s very low payout ratio.
Aflac paid out just 24% of earnings in 2016 and is expected to pay out 27% of earnings in fiscal 2017.
This gives the company plenty of room to continue growing its dividend payments even if earnings remain flat for a period of time.
The remainder of the company’s returns will be driven by its per-share intinsic value growth.
While book value is usually not a good approximation of intrinsic value, book value growth tends to approximate intrinsic value growth. In other words, the spread between book value and instrinc value tendsto remain constant over long periods of time. Warren Buffett is a proponent of using book value growth to approximate intrinsic value growth.
Looing at Aflac’s historical per-share book value growth can help us understand the insurer’s ability to grow intrinsic value.
Source: Value Line
Between 2001 and 2015, Aflac has compounded its book value per common share at a rate of 11.1% annually.
As a result of this strong growth, Aflac is a much larger enterprise today than it was in 2001. Accordingly, I believe future growth will be slower and investors can conservatively expect 7%-9% growth through full economic cycles moving forward.
To sum up, Aflac’s total returns will be composed of:
- 2.2% dividend yield
- 7%-9% growth in book value per share
For expected total returns of 9.2%-11.2% before the (likely positive) impact of valuation changes.
Based on a weighted index of price-to-earnings, price-to-book, and price-to-cash-flow, Aflac has the cheapest valuation of any Dividend Aristocrat.
The company also has many other attractive characteristics. It is the leader in the supplemental insurance industry and has a proven track record of compounding per-share book value over long periods of time.
With all that in mind, Aflac’s compelling valuation makes it a buy for long-term buy-and-hold investors.