On Sep 30, we issued an updated research report on Aflac Inc. (AFL). Although the company enjoys a healthy capital position, we remain cautious about its weak growth guidance and investment returns, given the sluggish economy faced in Japan.
This supplemental health insurer has delivered positive earnings surprises in all of the last four quarters with an average beat of 3.8%. The company’s second-quarter 2014 earnings was higher than the Zacks Consensus Estimate and the year-ago quarter figure by 4.4% and 2.5%, respectively.
While lower claims, expenses as well as lower loss ratios supported margins’ growth in the past quarters, benefit ratio are expected to deteriorate for the rest of 2014, owing to higher spending due to incremental sales initiatives.
Further, mounting expenses, sluggish sales, portfolio de-risking and the prevalent low interest rate environment have compelled management to tighten its earnings growth guidance at low single-digit growth in 2014.
The guidance reflects the negative impact of difficult comps, low interest rate environment, higher capital expenditures and weak yen/dollar exchange rate. Even the operating cash flow plunged 30% to $10.5 billion in 2013 and 45% to $3.13 billion at Jun 2014-end, primarily due to lower net income and tax liabilities. Incremental hedging in currency and interest rates along with a shift toward low-risk investment portfolio are adversely affecting portfolio yield.
A weakened sales outlook in both the US and Japan also raise concerns. Management projectsnew annualized sales in the US to witness a reduction of 4–8% in 2014, deteriorating from the prior outlook of 0–5%, owing to difficult comps. The bank channel sales in Japan are also expected to face a tough phase in the upcoming quarters.
Nevertheless, the company’s growth potential in an improved economic scenario is affirmed by the healthy ratings and capital ratios. This is also reflected by Aflac’s estimated risk-based capital of over 800% ratio at Jun 2014-end, higher than 786% generated at 2013-end, along with improved return on equity (ROE). Moreover, profit from repatriation (from Japan to the US) already outperformed management’s target of 127 billion yen in 2014, and rose to $1.3 billion in Jul 2014 (131.4 billion yen) from $771 million (76.8 billion yen) in 2013.
Overall, a stable economy, strong network alliance from Japan Post and investment restructuring should help the stock gather momentum in the long run, mitigate interest and currency risks and enhance competitive edge from peers like Unum group (UNM), Protective Life Corp. (PL) and Amerisafe Inc. (AMSF).
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