AFLAC at $60

In Barron’s, Vito J. Racanelli lays out the case for AFLAC ($AFL):

The company—which makes most of its money selling policies like supplemental insurance, disability and other sickness plans in Japan—has a decade-long track record of good sales, premiums, profits, and dividend growth that has continued right into the second quarter of this year. In the first six months of 2012, revenue rose 19% to $12.1 billion, while profits almost doubled to $1.27 billion or $2.72 per share. The dividend was hiked 10% to 66 cents per share.

So what’s not ducky about Aflac? In a word: Europe.

In a global world of abnormally low interest rates, Aflac, like insurers and investors the world over, is desperate to invest in assets with good yields, to match its liabilities. Japanese long government bonds—a natural asset for a business that gets 75% of its revenue and 80% of its earnings in yen—yield a paltry 0.80%, even lower than their U.S. counterparts.

So Aflac turned to yen-denominated preferred stocks of European banks, among other issues, in order to improve the performance of its investment portfolio, now about $100 billion.

The result: Since the European sovereign debt crisis began in 2010, “every time Europe sneezes, Aflac stock catches cold,” says Thomas Weary, chief investment officer of money-manager Lau Associates. Indeed, the results this year, good as they are, include an investment loss of $272 million or 58 cents per share in the second quarter. Much of that is from European assets, Weary adds.

But things are getting better on this score, Weary notes, and the stock’s relatively cheap valuation could be a good entry point for long-term investors.

Aflac has been spending a lot of management time this year on “de-risking” the portfolio of European preferred stocks and the like, Weary says. Such assets have been sold at a loss but they have dropped to about 5.3% of Aflac’s investment portfolio from 8.8% a year ago. Indeed, the company’s 2012 second-quarter investment loss was narrowed from $453 million or 96 cents per share in the year-earlier period. The downside is that the money might be reinvested elsewhere in lower-yielding assets.

Still, “the company’s made a lot of headway on de-risking Europe,” says Weary, and Lau Associates has been adding shares lately. And Aflac is in a good spot in Japan, which, like Europe, groans under a lot of government debt. With its aging demographic and a worsening debt issue, the Japanese will have to look to private insurers for a social safety net, he adds.

The stock of this $21.5 billion market-value company is cheap compared with both its own history and its peers. Aflac trades at a price-to-earnings (P/E) ratio of seven times consensus analysts’ earnings estimates of $6.52 this year. That’s about half its historical median P/E and a 40% discount to its peers, the money manager notes. That’s too cheap for a company with that track record, a strong balance sheet, and an average 17.5% return on equity, he avers. The dividend yield is 2.9%.

Given all that, a nine multiple is a more reasonable valuation for Aflac, says Weary. That would get the stock price to near $60, or 30% higher. As Aflac reduces its European exposure, investors might start to line up for its shares.

Posted by on September 4th, 2012 at 12:32 am


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