Qualitative Dividend Analysis of Aflac (AFL)

Aflac Incorporated (AFL), through its subsidiary, American Family Life Assurance Company of Columbus, provides supplemental health and life insurance products. Over the past week, insurer Aflac (AFL) increased quarterly distributions by 5.70% to 37 cents/share. This marked the 31st consecutive annual dividend increase for this dividend champion. This increase for roughly in line with the 6.10% dividend increase in 2012.

Over the past decade, this dividend champion has managed to boost distributions by 19.30% per year. Over the past five years however, the growth rate has decreased to 10.90%./year.

In my previous analysis of the stock, it was trading at 8.40 times earnings and yielded 2.90%. Analysts expect the company to earn $6.18/share in 2013 and $6.40/share by 2014. In comparison, the company earned $6.11/share in 2012 and $4.13/share in 2011. Given the slowdown in earnings expectations, chances are that dividend growth would likely be slower than the past.

The slow rate of dividend growth is disappointing. However, as a long-term investor I have found that I should have more patience, and not let a single point of data influence me into tinkering too much with my portfolio. After all, dividend growth rates fluctuate over time. If you purchased Aflac at starting yields above 2.50%, your dividend income is still growing at twice the historical rate of inflation.

Insurers like Aflac typically do not earn much from the spread between collecting premiums and paying out benefits. Most of their profits are derived from holding the so called “float”, which is the premiums received before payouts, and invest it in fixed income securities. As any serious investor worth their salt knows, interest rates have been a little low, to say the least. However, if interest rates were to increase over the next five years for example, this float is going to generate much higher earnings for companies like Aflac. Therefore, insurance companies are a play on rising interest rates over time.

The thing that is most interest about Aflac is that although it is a US based company, it generates the majority of revenues from Japan. Basically, the company sells supplemental life insurance and cancer insurance policies through approximately 120,000 agents. The company targets employers, and has managed to add its supplemental insurance policies as part of the overall benefits packages that employers offer to their workers. This keeps costs relatively low, and provides a very good scale and the ability to generate recurring revenues. The scale is because 90% of employers in Japan offer the Aflac insurance and because Aflac is selling to employers, rather than target individual employees – hence the salesforce gets most bang for their efforts. The recurring revenues are generated from the payroll deductions from the employees who signed up through their employer plans.

The company is also able to find new ways to sell more insurance, through creating new products or finding new channels. It started selling insurance through the bank channels in 2007, and this has been a big success. Aflac would also be a beneficiary of any technological improvements, as this could further decrease administrative costs for example.

Of course, the risk to Aflac is the fact that it earns revenues in Japan, where a large portion of population is aging and the country has a high debt levels, coupled with very low interest rates. Approximately 40% of Aflac’s investments are in Japanese bonds. This leaves the company somewhat less exposed to depreciation of the Japanese currency, although it still could have an adverse impact in the short-term. Longer term, I view the effect of currency fluctuations on net incomes as a wash, since currencies of developed countries are not debased significantly relative to the US dollar.

That being said, the company is still growing operations in Japan. Its competitive strengths include being a low cost producer, and its distributions network of selling policies though brokers, banks and the Japan Post Office.

The next growth kicker could be the Aflac US operations. Currently, it is providing insurance that offers protection against income and asset loss. For Aflac, voluntary insurance sold at the
worksite represents virtually all of its focus, whereas its competitors tend to offer voluntary products as a peripheral line of business. The company has also started in 2009 to target larger businesses, by offering Group Plans to the employees of those businesses.

The stock is attractively valued at 9.90 times earnings, but yields only 2.30% at the moment. I would consider adding to my position in the stock on dips below $59.

Full Disclosure: Long AFL

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