On Mar 13, we issued an updated research report on Aflac Inc. AFL. We remain cautious of the tepid earnings guidance and investment returns, given the sluggish economy of Japan. Yet, Aflac’s product expertise, healthy capital ratios, dividend hike, accelerated buybacks and better-than-expected profit repatriation in 2014 boost confidence.
Aflac’s healthy risk-based capital and financial leverage continue to induce optimism. The recent $1 billion notes issue will facilitate reduction of borrowing costs given its low interest rates, thereby maintaining modest financial leverage around 25% in the near- to mid-term.
The new cancer product launched last year led to 176% growth in cancer insurance sales in fourth-quarter 2014. Subsequently, third sector sales in Japan improved 6.1% in 2014, also within the targeted 2–7% range. Going ahead, third sector sales are projected to grow by about 15% in the first nine months of 2015, while some tapering is expected in fourth-quarter 2015 due to difficult comps.
Moreover, profit from repatriation outperformed the management target of 127 billion yen from Japan to the U.S. in 2014, and rose to $1.7 billion in 2014 (181.4 billion yen) from $771 million (76.8 billion yen) in 2013, $422 (33.1 billion yen) million in 2012. As of Dec 2014, about 157.5 billion yen of foreign exchange forwards were hedged for future profit repatriation.
Meanwhile, most of the decline in investment due to Japan's consumption tax hike, from 5% to 8% effective Apr 2014, has started to bottom out. Based on these factors, management also expects earnings growth to gradually rebound beyond 2015.
However, the challenging operating environment in Japan have been hampering sales, that accounted for about 72% of revenues in 2014, deteriorating from 74% in 2013, 78% in 2012 and 83% in 2011. Declining sales of WAYS products also led to the decline in bank channel sales of 51.3% in 2013 and 47.3% in 2014 (accounting for 21.5% of new premium sales), indicating a tough phase in the upcoming quarters.
Furthermore, despite 48% of its investments being dollar-denominated, the total portfolio yield in the U.S. declined to 5.89% in 2014 from 6.01% in 2013 and 6.28% in 2012. Alongside, new money yield and return on average invested assets have suffered significantly in Japan. Even operating cash flow plunged 30% to $10.5 billion in 2013 and 37% to $6.6 billion in 2014, primarily due to lower net income and tax liabilities. These factors still keep us at bay.
Earnings Review
This Zacks Rank #3 (Hold) stock has delivered positive earnings surprises in three of the last four quarters, breaking even in one, with an average beat of 4.1%. Moreover, the company’s fourth-quarter 2014 earnings per share came in line with the Zacks Consensus Estimate but lagged the year-ago quarter figure by 7%. Lower benefits, claims and operating expenses were more than offset by lower revenues.
Overall, a cautious risk-reward profile in the near term has led the Zacks Consensus Estimate for 2014 and 2016 to dip by a nickel and a penny to $6.04 and $6.43 per share, respectively, in the last 60 days. However, the Most Accurate estimate for Aflac’s 2015 and 2016 earnings currently stand at $6.10 and $6.45 a share, translating into Earnings ESP of +1.0% and +0.3%, respectively. This indicates possibility of earnings accretion for both this year and the next.
Key Picks in the Sector
Better-ranked insurers include Amerisafe Inc. AMSF, MGIC Investment Corp. MTG and Employers Holdings Inc. EIG, all of which sport a Zacks Rank #1 (Strong Buy).
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