A Top-Tier Firm Hiding In Plain Sight
Value investing can be tough. It means thinking in a contrarian manner, while the investing herd stampedes in another direction.
Value opportunities usually occur when something is going wrong for a company. Recognizing a headwind that is temporary or fixable, especially when it affects an otherwise healthy company, is what value investors dream of.
Aflac, Inc. (NYSE: AFL) is a specialty insurer that offers disability and supplemental medical insurance products in the United States and Japan. Although famous for a talking duck mascot, this is a spectacularly run company.
Aflac has raised its dividend for 33 consecutive years, making it a member of the “Dividend Aristocrats.” In each of the past 10 years, even during the financial crisis of 2008, it has achieved a 15% or better return on equity. This company controls a very specific niche in the market and is the undisputed leader in supplemental insurance products.
Despite the fact that it’s headquartered here in the United States, most of Aflac’s business comes from Japan. In 2014, Japanese operations accounted for more than 70% of Aflac’s revenue.
In Japan, the company is performing well, consistently adding policies and growing premium income year in and year out.
In contrast, Aflac’s American operations boosted premium income by just more than 2% annually during the past three years. However, early results from the restructuring of its U.S. sales force is already having a positive impact. The company achieved a 14% sales increase during the fourth quarter of 2014.
Despite Aflac’s generally excellent operational performance, the stock has been flat for the past 18 months. Blame goes to currency effects.
In 2013, in an effort to fight a decade of deflation, Japan’s central bank began a massive quantitative easing program. As a result, the value of the yen has tanked versus the U.S. dollar.
A sharply weakening yen means that even though sales and earnings in Japan are growing, Aflac’s reported consolidated business performance in U.S. dollars shows shrinking revenues and declining earnings. In 2014, the weak yen reduced overall operating earnings by more than 4%.
#-ad_banner-#Aflac also feels the effect of quantitative easing (in both of its markets) when it’s looking to invest its insurance float. In order to maintain the liquidity necessary to pay claims quickly, Aflac invests primarily in government bonds. Quantitative easing has driven down bond yields to all-time lows.
In 2014, Aflac Japan earned a paltry 2.16% yield on new-money investments. In the United States, Aflac’s yields on new investments was just 4.32%. Aflac generates a significant portion of its earnings from its investment portfolio, so when interest rates do eventually rise, Aflac will benefit massively.
Investors must believe negative currency fluctuations and low interest rates are going to last forever because they have pushed Aflac’s valuation down to absurdly low levels. Aflac trades at less than 10 times last year’s earnings, while the S&P 500 trades at nearly twice that multiple. While the daily chorus from the media is that stock valuations are overly stretched, Aflac is a bargain hiding in plain sight.
Risks To Consider: Aflac’s slow U.S. sales growth is a concern, and recent rumblings coming from the Federal Reserve suggest that rate rises might come more gradually than some investors anticipate.
Action To Take –> Aflac has several catalysts that could propel the stock higher including a reversal in the yen-to-dollar exchange rate and higher interest rates. The only reason investors can buy this stock so cheaply is because these catalysts might take a while to materialize.
Aflac isn’t waiting around. The company bought back more than $600 million worth of shares in the first quarter of 2015 and still has more than $1 billion left in its current buyback authorization. Aflac will reward shareholders who buy and stay patient, while the yen stabilizes and rates rise.
Share repurchases are such a powerful tool that StreetAuthority devoted an entire newsletter to identifying shareholder-friendly firms that pay dividends and buy back shares. These stocks, which we call Total Yield stocks, have proven to beat the market — even during the 2008 financial crisis and the dot-com bubble — and serve as reliable income investments. To find out more about Total Yield investing, click here.