We reiterate our recommendation on Aflac Inc. (AFL) at Neutral, based on the current sustainability factor. The company’s second quarter operating earnings per share of $1.56 came in a couple higher than the Zacks Consensus Estimate of $1.54 but modestly exceeded $1.35 reported in the year-ago quarter.
Growth in the second quarter was supported by higher premium income, modest investment yields, favourable dollar/yen exchange rate and improvement in the U.S. operations. However, higher claims and benefits, lower-than-expected top line and higher investment losses due to de-risking activities partially dampened the positives.
Aflac has been achieving its earnings target for the past 21 years, which is reflected in its consistent dividend increment. The company’s strong brand name and solid business model enabled it to improve earnings considerably faster than other life and health insurers such as Unum Group (UNM) and Catalyst Health Solutions Inc. (CHSI).
Aflac had been strengthening its Japanese operations regularly, which also helped itself to survive the catastrophe losses better than its peers. Japan’s revenues accounted for 86% of the company’s total revenue in the first half of 2011, steadily increasing from 77% in 2010, 73% in 2009. Factoring all the growth prospects, management has raised its guidance for 2012 to 2%–5% from the prior expectation of negative growth over 2011.
Despite challenging economic conditions that have marred the insurance industry both in Japan and the U.S., Aflac continues to enjoy a fairly liquid position. This gets further validated by regular dividend increments and resumption of the share buy back program.
The company’s investments and cash position are experiencing steady growth. It increased to $93.0 billion at the end of the first half of 2011 from $88.2 billion in 2010, thereby providing ample operating leverage to the balance sheet. Further, Aflac’s National Association of Insurance Commissioners (NAIC) risk-based capital ratio was estimated in the range of 480%–520% in the second quarter of 2011, which is impressive given the ongoing de-risking program.
Meanwhile, Aflac also aims to get rid of its problem investments in Europe through its proactive de-risking process, which is expected to last over the next 12–15 months. While the company has already cleaned out all its risk exposure in Greece at the end of the second quarter, it also reduced significant investments in Ireland, Portugal, Italy and Spain. We believe Aflac is quite capable of sustaining losses from these investments. Going ahead, the strong capital and surplus cash position are expected to mitigate this balance sheet risk and provide liquidity cushion to its long-term growth.
However, Aflac continues to be hit by intense economic volatility, continued fluctuation of the yen against the dollar, changes in interest rates, changes in credit spreads and defaults, market liquidity and declines in equity price.
Despite the fact that Aflac is indulging in de-risking activities, it is moving toward safer investments with lower yields, which will further lessen investment income. Moreover, the company’s substantial exposure to European financial institutions' hybrid securities, below-investment-grade debt and perpetual securities is likely to result in statutory investment losses and lower reinvestment yields, thereby escalating the financial and capital risk.
Increased losses in the investment portfolio and lower income from the variable annuity business are expected to continue to hurt earnings at least in the near term, until the markets witness steady recovery.
Besides, increasing expenses from operations, benefits and claims continue to weigh on margins. The devastating earthquake and tsunami that hit Japan in March 2011 have resulted in increasing catastrophe losses and weakening claims-paying ability. This is also reflected in management’s estimation of earnings at the lower-end of the guidance.
Overall, weighing all the pros and cons, the Zacks Consensus Estimate of earnings is currently pegged at $1.58 per share, up 16% year over year, for the third quarter of 2011. This is also within management’s guidance of $1.54–$1.60 per share. Ten of the fifteen firms covering the stock have revised their estimates upward for the upcoming quarter, while a couple of downward revisions were witnessed. For 2011, earnings are estimated to be $6.30 per share, up about 14% year over year.
Additionally, the quantitative Zacks Rank for Aflac is currently #3, indicating no clear directional pressure on the shares over the near term.
AFLAC INC (AFL): Free Stock Analysis Report
CATALYST HEALTH (CHSI): Free Stock Analysis Report
UNUM GROUP (UNM): Free Stock Analysis Report
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