AFLAC Incorporated - Part 3
What is this boring companies story?
Welcome to part 3 of this exploration of AFLAC Incorporated, an American Insurance company whose business is focused on the Japanese Market.
In the previous post we made a number of calculations that allowed us to estimate the value of AFLAC, both right now, and in the future.
We used these values to determine a range in which the price of the company would make it a sound investment to own.
That being said, investing isn’t only about numbers, quantitative measures can only tell you so much, and they have the disadvantage that sometimes there’s something missing from them.
I know that a lot of people look at stocks as nothing more than a ticker symbol in a newspaper (or a screen nowadays) that goes up and down as if by chance.
More knowledgeable investors will realize that it’s not so much chance, as it is the underlying value of the company in question.
Earnings, asset value, management quality. These are all things that not only help investors determine how much to pay for a stock, but also estimate the underlying health and quality of a business.
In my view, there is really no replacement to cracking open a 10-K and reviewing a companies companies financials.
A company whose price does not reflect the value of those financials is simply un-investable and should be dismissed until either the financials come up to the price, or the price goes down to the financials.
All the same however, just because a company has OK financials at an attractive price doesn’t mean that company should be bought.
The thing missing here is the story of the company.
The story of the company is difficult to define, and most importantly it changes over time.
AFLAC today isn’t the little company founded by two brother in 1955 that had less than 6500 policyholders in its first year, and so its story today isn’t the same story that it was 30 or 40 years ago.
The story is what this company is about, it’s where its been and where its going.
What do we want out of a Story?
Ultimately we are investors and our purposes when it comes to discovering the story of a company are inherently connected with both the financial path of the company, and the way ownership of the company will benefit ourselves.
In other words, when it comes to the story of the company we want to be able to answer the following questions:
What can an investor reasonably expect the company to do in the future?
What are the risks involved in the business?
Are there any catalysts that might make the business more attractive?
How will an investor make back its investment?
If we know enough about a company to answer these questions, and that answer is satisfactory for our objectives, then we can be fairly confident in the company and our investment prospects.
So let’s see if we can answer these questions for AFLAC:
What can we expect AFLAC to do in the future?
The good thing about the insurance business is that it is above all predictable.
The business model is long-term focused, and high levels of regulation make any sudden or unexpected changes not only unlikely, but also often impossible.
We know that AFLAC has been focusing on selling Cancer insurance in recent times, and that will not just continue into the future, but the premiums and revenues coming from those insurance contracts will continue to come in for the next decade or so.
We also know that most of AFLACs business is located in Japan, where they are a major insurance company.
This means that its fortunes will be largely correlated with the Japanese Insurance market. So the question there is, is the Japanese insurance market going anywhere?
Japan is experiencing a decrease in population, and that will certainly play a role in AFLACs future, but it’s a slow decline and above all it’s been predicted for some time.
The effects of COVID will also be felt in AFLAC, not just the additional costs when it comes to those AFLAC has insured, but also the effects that the economic disruption that has been 2020 has had on its ability to acquire additional business.
I think it is fair to say that in the very short term its business will suffer, but given its solid balance sheet, and good margins I don’t predict that this will be a long term problem for the company.
Predictable is the key word here.
Neither AFLAC nor the countries and industries it operates in are unstable. This is a mature company operating in mature industries with well established risk profiles and business standards.
This leads me to believe that AFLAC will slightly decline in revenue (and consequently earnings) in the near future (2-3 years) as a result of the pandemic.
On a longer term scenario it will be constrained by the Japanese economy and demographics, and is therefore unlikely to grow quickly there.
Whatever growth that comes will happen in its north American operations, which AFLAC has been prioritizing in the past decade or so, going from 85% of its revenues coming from Japan in 2012 to 68% in 2020.
This increase in value of its American business is happening both from organic growth, as well as through acquisitions, such as its recent acquisition of Zurich North America’s US Corporate Life and Pensions business.
It is reasonable to expect similar acquisitions and growth to continue for the foreseeable future.
In summary, we expect a small decline in the near term, with growth inline with the Japanese and US economy in the longer term.
What are the risks involved in the business?
This part of the story is actually the easiest to get and understand, probably because every company is legally required to make them public in every 10-K they file with the SEC.
In AFLAC (and most other companies) that is right at the beginning of the 10-K in “Item 1A. Risk Factors”:
You can take your time and read them out to get additional detail, most of them are pretty well explained and detailed, and I would encourage every would be investor to take a long hard read through them before making the decision to buy.
They generally classify their risks into 4 sections, investment risks, operational risks, regulatory risks and general risk factors.
For Investment risks, there are:
Difficult conditions in global capital markets and the economy, including those caused by the novel coronavirus COVID-19, could have a material adverse effect on the Company's investments, capital position, revenue, profitability, and liquidity and harm the Company's business
Defaults, downgrades, widening credit spreads or other events impairing the value of the fixed maturity securities and loan receivables in the Company's investment portfolio may reduce the Company's earnings and capital position.
The Company is exposed to significant interest rate risk, which may adversely affect its results of operations, financial condition and liquidity.
The Company's concentration of business in Japan poses risks to its operations and financial condition.
Lack of availability of acceptable yen-denominated investments could adversely affect the Company's results of operations, financial position or liquidity.
The Company is exposed to foreign currency fluctuations in the yen/dollar exchange rate.
The valuation of the Company's investments and derivatives includes methodologies, estimations and assumptions that are subject to differing interpretations and could result in changes to investment valuations that may adversely affect the Company's results of operations or financial condition.
The determination of the amount of expected credit losses recorded on the Company's investments is based on significant valuation judgments and could materially impact its results of operations or financial position.
Any decrease in the Company's financial strength or debt ratings may have an adverse effect on its competitive position and access to liquidity and capital.
A decline in the creditworthiness of other financial institutions could adversely affect the Company
The concentration of the Company's investment portfolios in any particular single-issuer or sector of the economy may have an adverse effect on the Company's financial position or results of operations.
For Operational Risks:
Major public health issues, and specifically the novel coronavirus COVID-19 and any resulting economic effects could have an adverse impact on the Company's financial condition and results of operations and other aspects of its business
Sales of the Company's products and services are dependent on its ability to attract, retain and support a network of qualified sales associates, brokers and employees in the U.S. and sales associates and other distribution partners in Japan.
If future policy benefits, claims or expenses exceed those anticipated in establishing premiums and reserves, the Company's financial results would be adversely affected.
The success of the Company's business depends in part on effective information technology systems and on continuing to develop and implement improvements in technology.
Interruption in telecommunication, information technology and other operational systems, or a failure to maintain the security, confidentiality, integrity or privacy of sensitive data residing on such systems, could harm the Company's business.
As a holding company, the Parent Company depends on the ability of its subsidiaries to transfer funds to it to meet its debt service and other obligations and to pay dividends on its common stock.
The Company's risk management policies and procedures may prove to be ineffective and leave the Company exposed to unidentified or unanticipated risk, which could adversely affect the Company's businesses or result in losses
For Regulatory Risks:
Events related to the ongoing Japan Post investigation and other matters regarding sales of Japan Post Insurance products could negatively impact the Company’s sales and results of operations
Tax rates applicable to the Company may change.
If the Company fails to comply with restrictions on customer privacy and information security, including taking steps to ensure that its third-party service providers and business associates who access, store, process or transmit sensitive customer information maintain its security, integrity, confidentiality and availability, the Company's reputation and business operations could be materially adversely affected.
Extensive regulation and changes in legislation can impact profitability and growth.
And for General Risks:
Competition could adversely affect the Company's ability to increase or maintain its market share or profitability
Catastrophic events, including as a result of climate change, could adversely affect the Company's financial condition and results of operations as well as the availability of the Company’s infrastructure and systems
Events, including those external to the Company's operations, could damage the Company's reputation
The Company depends heavily on key management personnel, and the loss of services of one or more of its key executives could harm the Company's business.
Changes in accounting standards issued by the Financial Accounting Standard Boards (FASB) or other standard-setting bodies may adversely affect the Company's financial statements
The Company faces risks related to litigation, regulatory investigations and inquiry and other matters.
Allegations or determinations of agent misclassification could adversely affect the Company’s results of operations, financial condition and liquidity.
If any one of these risks concerns you, I would encourage you to dig deeper into it.
I know I did in regards to the Japan Post investigation, and at least on my end I am satisfied that AFLAC has not done anything that might be problematic.
Are there any catalysts that might make the business more attractive?
A catalyst is something that might significantly change a companies fortunes.
It can be a new product, a change in customers tastes, or some other external or internal factor that will change.
Not every company has or needs a catalyst. Indeed, boring companies in mature industries like AFLAC often don’t have or need one.
They are profitable, and expected to continue to be profitable into the future. If everything is going well, and the company is being sold below its fair value, you don’t actually need a catalyst to buy.
But if there is a catalyst, then a good company can often become a great company!
So does AFLAC have a catalyst?
At first glance it doesn’t look like it.
Insurance is a mature business, and AFLAC is big enough in mature markets that it can’t exactly come in and take market share.
Regulatory concerns also prevent it from coming up with new products to sell.
So AFLAC is making about as much money as it can, and there’s no real way for it to make big moves, either good or bad…
But what if the catalyst isn’t caused by AFLAC?
We talked before about how AFLAC was harmed by the increased valuation of the Yen after 2012. This was a big reason as to why its revenue has still not reached its all time high of 25 Billion dollars a year.
But exchange rates go both ways, and during this Covid pandemic the Federal Reserve has created a high amount of US Dollars that, like it or not, will end up in the economy and the financial system in general.
This increase in dollars was proportional to the economic impact of COVID, since Japan has not suffered as much as the US in terms of Covid economic impacts, the policies that the bank of Japan has taken were not (and did not need to be) as impactful.
It’s that impact that I think might be a catalyst.
The higher impact on the USD will likely have 2 main potential catalysts:
It will result in higher financial asset prices, of which AFLAC is a large owner of.
It will result in a devaluation of the USD in favor of the Yen, which will result in its Japanese operations becoming more profitable in USD terms
Both of those things might result in a higher valuation for AFLAC if they are realized.
The first impact we already see some of, with the low yields on current fixed income assets. While this will have a negative impact in the long term, in the short and medium term AFLAC will be a beneficiary since they already own many of these assets.
The second impact will result in the opposite of what we saw in the 2012-2016 period, where instead of earnings being artificially depressed, they instead become artificially inflated.
While this won’t have a significant impact in the long term, it will positively benefit its short and medium term cash position, which would enable additional acquisitions in its growing US market, like the Zurich acquisition we’ve seen last year. This might in turn make its American operations more dynamic.
Finally, since it will increase both the earnings and book value of AFLAC, this may result in its share price appreciating accordingly in the short to mid term.
While I am perfectly happy owning AFLAC forever, this might bring about periods of over valuation which I am happy to take advantage of.
How will an investor make back its investment?
Finally we get to the rub of it.
How do I (or any investor) make money from owning AFLAC? At the end of the day how do I get a return on my investment?
A lot of people seem to think that stocks are just ticker symbols that go up and down, and that the way to make money is to buy when its down and sell when its up.
This is a terrible way to go about it, and almost always a recipe for financial disaster.
Behind every ticker symbol is a company with real assets and real people working for it.
As a shareholder you own that company, the buildings and factories the company owns belong to you, and the people that work for it, from the janitor to the CEO are your employees.
The money that the company makes is your money.
Don’t misunderstand my words, I am not advocating that the company should return every cent of profit to its shareholders, that would not be prudent.
Companies should always keep some of their earnings, whether that is to reinvest back into the business, or just to keep a rainy day fund that will allow it to weather storms like the one we are in right now.
But once that rainy day fund is there, and there are no prudent investments to make, I very much prefer that the company returns that capital to shareholders so that they may chose how and where to reinvest it.
So does AFLAC return that cash to shareholders? Are AFLAC shareholders receiving any benefits from the company for their ownership of it?
Well, like we discussed in Part 1 Aflac has been regularly buying back shares and returning capital that way.
If we have a look at their 10-K we can see managements comments on the matter:
This is a very encouraging sign, because it indicates that they plan on continuing their shareholder-value creating policies of Dividends and Share-Buybacks.
In fact, you may notice that they talked about issuing Dividends, which is something that we didn’t previously discuss, or account for in our valuation metrics.
Does AFLAC pay a dividend?
Does it regularly increase the amount they pay out?
Is it sustainable going forward?
The answer to all of these things is a resounding YES.
AFLAC does pay a dividend, and indeed they are not just a reliable dividend payer, but they are a Dividend Aristocrat with a very respectable 39 years of consecutive dividend increases.
In fact, on average AFLAC has increased its dividend almost 8% every year for the last 5 years.
The dividend is also very sustainable, and has a lot of room to grow, given that AFLAC only pays out around 25% of its earnings as dividends.
If we go to Seeking Alpha we can see its Dividend history:
A steady and consistent stream of increasing dividends going back to the 80s is exactly what we want to see.
This, combined with consistent stock buybacks are the recipe for shareholder value creation.
We know what AFLAC is and does.
We know its course over the past 10 years.
We know where it will go in the future.
We know how owning it will benefit us.
We know (roughly) how much the company is worth.
So now we need to decide whether we will pull the trigger and invest in AFLAC.
To me, the answer is YES.
The company is at an attractive price, and there are no major issues hidden away underneath the carpet. I like its business, its future prospects and I am comfortable owning it for the long term.
I may be wrong, perhaps I missed something obvious that will bring this company crashing down in flames. Or perhaps I’m just unlucky and some happenstance will cause troubles to the company that weakens my thesis for it.
Ultimately I don’t know the future, but as far as I can see AFLAC is a good investment, so i will (and have) invest in it.
Speaking of which, if you already are an AFLAC shareholder like I am, I would encourage you to go read your proxy statement and vote in the next general meeting! You own this company, so act like it!
You may have a different view, and if you do i would encourage you to comment down below, or tweet at me. I am always open to listening to other views.
I’ll see you next time!