AFLAC Incorporated - Part 1
Why you should be bullish about this boring company
In my last post, I mentioned I was particularly bullish on AFLAC , and so today we will be talking about this company, and why I think it is a great investment opportunity.
What is AFLAC?
As per their 10-K report, AFLAC is:
Aflac Incorporated (the Parent Company) was incorporated in 1973 under the laws of the state of Georgia. The Parent Company and its subsidiaries (collectively, the Company) provide financial protection to more than 50 million people worldwide. The Company’s principal business is supplemental health and life insurance products with the goal to provide customers the best value in supplemental insurance products in the United States (U.S.) and Japan. When a policyholder or insured gets sick or hurt, the Company pays cash benefits fairly and promptly for eligible claims. Throughout its 65 year history, the Company’s supplemental insurance policies have given policyholders the opportunity to focus on recovery, not financial stress.
In other words, AFLAC is an American Insurance Company operating primarily in the United States and Japan.
Japan in fact provides around 2/3rds of their revenue via their subsidiary AFLAC Japan.
Their business model involves collecting premiums from their clients, and paying some cash directly to them (or their beneficiaries) if their clients have some health issues or pass away.
They make money by paying out less than they collect, as well as by getting some investment returns on the premiums they have collected.
This is a boring, simple and easy to understand business model, and as long as they didn’t massively miscalculate how much money they will have to pay out to their customers, there isn’t really a lot that can go wrong.
In short, AFLAC is the type of business where regular and consistent revenues and profits are made, which is ideal for a long term buy and hold investor.
Strengths and Weaknesses
No company is perfect, and every company has their own strengths and weaknesses.
AFLAC is no different, and the way they are structured and the markets they participate in make some of those strengths clear, and some of the weaknesses also.
Insurance is a highly regulated field, which reduces new competition
Enduring Competitive advantages have allowed it to capture 25% of the Japanese health and life insurance market
Low payout ratio permits regular dividend increases into the future
They have demonstrated a long standing commitment to returning capital to shareholders via dividends and share buybacks
High exposure to the Japanese Market and Yen-USD currency fluctuations
Complex regulatory environment means the company is exposed to political risks and caps potential profits
Covid and other significant disasters may heavily impact the company
Stagnating revenue and earnings in the past 10 years
That last bit maybe be a bit of a sticking point for most investors, after all, few people want to invest in a company that is making less money today than it made 10 year ago.
Indeed, if your investment objectives require aggressive and continuous growth of revenue and bottom line, then I don’t believe AFLAC is the company for you.
But for someone who is happy to get a steady and consistent business, at a price that is below what i believe is their fair value, then AFLAC may be the stock for you.
What do i mean by that? Well, let’s have a look at their numbers…
Let’s see the key numbers over the past 10 years:
A bit too confusing? Let’s make some charts:
So revenue has been pretty flat, having peaked in 2012 at around 25 Billion USD. That’s also around the time that the yen had some pretty severe appreciation against the USD:
Given that most of the companies revenues and profits come from Japan, where 2/3rds of its business is made, it’s fairly safe to say that the exchange rates played a major role in the revenues being flat.
That being said, the company has been consistently profitable throughout, doubling its net earnings over this 10 year period.
Another important thing to keep track of, is the interest expense. Companies with high interest expenses are usually heavily leveraged, which isn’t good for long term investment risk adjusted returns.
In general, low long term debt is a good indication of a company with a durable competitive advantage, and AFLAC has consistently kept their debt expenditures at around 1% of revenue.
Their margins are also looking very good. Generally speaking companies with pre-tax profit margins consistently above 20% have some sort of competitive advantage that make them profitable to own as I discussed this in a previous post.
The fact that AFLAC has managed to consistently keep their margins around a very healthy 18.1% is a very good indication that the company has an above average competitive advantage.
Let’s have a look at their “Per Share” Metrics:
So their per share earnings have consistently increasing, and they have been buying back shares every year.
Buying back shares can be both good and back. It can be a way to transfer wealth to shareholders without it being taxed, or it can be a way for management to financially engineer their way into bonuses or extra compensation.
In this particular case, I’m not too concerned. The business is stable, and the buybacks look like they are a long standing commitment to returning capital to shareholders in a tax efficient way.
That being said, we now have 716 192 million shares outstanding, but we started with 473 085 million… What happened in 2018?
The answer is simple, there was a 2-for-1 stock split in 2018. Nothing out of the ordinary, it just means their stock became so expensive that the company decided to split it so new investors wouldn’t have to drop $100+ just to get a share.
This means that someone who bought 1 share in 2010 at $4.92 earnings per share, would effectively be earning $13.34 per share.
That’s a CAGR of 10.49%, not too bad for a company whose revenues and earnings have been stagnant since 2012 due to currency headwinds!
Here’s the balance sheet as of December 31st 2020:
There’s a lot to unpack here, but lets keep it simple and look at the key numbers i highlighted.
Here you can see the assets, these are things the company owns and that it can sell for some cash.
The first thing you’ll notice in the assets is that the vast majority of AFLAC assets are in the section labelled “Total Investments and Cash”. Insurance companies are usually required to keep enough cash in either cash, or low risk assets such as government bonds.
These are low return on investment assets, however they have the benefit of being highly liquid. That is, they can very quickly and very easily be turned into cash on hand without any major loss of value in doing so.
What this effectively means is that 90% of AFLAC assets are either in cash, or as close to cash as you can get.
When you buy AFLAC, you’re not just buying a profitable company, you’re also buying a pile of cash.
How big is that pile? Well, to find that out we need to have a look at the liabilities:
In yellow, you can see the total policy liabilities, this is essentially money that the company owes its clients as a result of the policies that it sold. In a way, you can think of this as the cost of the goods (policies) it sold, and higher amounts here, generally indicates more business being made.
In light orange, you can see the notes payable and lease obligations. This is essentially the companies long term debt, and you can see that its only a very small amount of all of their liabilities.
In fact, if you compare it with its net earnings, we can see that AFLAC can pay off all of its long term debts in only a couple of years if it really needs to.
This is a very encouraging sign, because companies with a durable competitive advantage generally don’t need to make use of large amounts of long term debt.
Finally in dark orange, we see the total liabilities, that is, everything that the company owes.
With this we can now calculate just how big that pile of cash on our balance sheet is really ours, and which part has to be used to pay our debts:
So when we buy AFLAC, we’re also buying a pile of 18 Billion US Dollars!
When we consider that its market cap right now is 35 Billion dollars, we can see that about half of the cost of buying AFLAC is effectively refunded immediately!
In essence, we’re buying the business, its earning power, and all of its non-cash assets for around 17 Billion dollars! That’s about as much money as the company earns in 3 years!
Let’s check out the rest of the Shareholders Equity:
See that retained earnings? That’s how much money the company earned, and that it chose to reinvest in the business.
The fact that it makes up the bulk of the shareholders equity means the company has been very profitable indeed.
The Treasury Stock might look bad, with a big negative 15 billion number on it, but it’s actually a good thing! That’s 15 billion that was returned directly to the owners!
Overall the total shareholders equity is 33 Billion, which is very close to its current market cap. This means that AFLAC is trading very close to its book value.
This is usually indicative of a company in distress, after all, if a company is trading close to the cost of its assets… Doesn’t that mean the market isn’t valuing its business at all?
Let’s have a look at the values over time:
So the cash they have on hand has been increasing over time, which is pretty good.
Their long term debt has been increasing as well, though its still low enough to be manageable.
What about their shareholders equity?
Their treasury stock has been decreasing, which means they have been buying back their own stock regularly.
In fact, those regular buybacks seem to have started around 2012, which coincides with that high watermark in revenues. So it looks like they have been distributing those earnings to shareholders.
Their retained earnings has been increasing steadily as well, which means they have been profitable throughout, and have not spent all of their earnings on buybacks or dividends.
Accordingly their shareholders equity has been on the up and up, more than doubling during this past decade.
What’s with this valuation?
How can this be? AFLAC is clearly a profitable company, in fact, in the 10 years we’ve seen it hasn’t posted a single loss and its margins have been a steady 18%.
And yet, the market is valuing it at close to its book value. Hell, a few months ago it was valuing it at below the cash it had in the bank!
What is up with this?
Honestly, I don’t know.
My best guess is that because AFLAC isn’t a high flying tech stock, and is heavily dependent on a foreign market whose demographic prospects aren’t the best, most investors simply overlook it.
Insurance isn’t a sexy industry like self-driving cars, nor is it as profitable as selling 1000$ iPhones, but to me that’s fine.
I don’t want sexy. I don’t like high flying tech stocks that never turned a profit.
All I want is a nice, steady company that regularly pays me an increasing stream of income, and whose prospects I feel are bright.
As far as I can see, AFLAC is such a company, so now we just need to calculate the point in which the price that we pay for AFLAC is lower than the value AFLAC provides.
We will do that in the next post, where we will take all of the data here, and make some simple calculations to come up with what I feel is a fair valuation for AFLAC.
Let me know what you think!
And as always, if you have any questions or comments, shoot them on Twitter @TiagoDias_VC or down below!
I’ll see you next time!