Aflac Inc.’s (AFL) third-quarter 2012 operating earnings per share of $1.77 modestly exceeded the Zacks Consensus Estimate of $1.66 and the year-ago quarter’s earnings of $1.65. Operating earnings improved 7.9% year over year to $831 million. A slightly weak yen/dollar exchange rate had nil impact on the operating earnings.
Operating earnings in the reported quarter excluded after-tax negative impact of realized investment gains from securities transactions and impairments of $124 million or 26 cents per share compared with $112 million or 23 cents per share in the year-ago quarter. Additionally, a positive impact of derivative and hedging activities worth $62 million or 13 cents per share affected the operating earnings in the reported quarter, as opposed to the negative impact of $146 million or 31 cents per share recorded in the year-ago period.
Including one-time items, Aflac’s GAAP net income in the reported quarter surged 38.1% to $1.02 million or $2.16 per share against $736 million or $1.57 per share in the year-ago period. Total acquisition and operating expenses moved up 4.2% year over year to $1.44 billion, while benefits and claims spurted 11.8% year over year to about $3.93 billion. Meanwhile, lower tax rate raised operating earnings by $17.5 million or 4 cents a share.
Total revenue for the reported quarter augmented 14.4% year over year to $6.85 billion, also surpassing the Zacks Consensus Estimate of $6.43 billion. Despite the ongoing derisking activities, weak yen and the low-rate environment, total revenue benefited from consistent improvement in the U.S. and Japan. While Aflac Japan contributed 80% to the total revenue, Aflac U.S. contributed the remaining 20%.
Total revenue in Japan increased 8.9% year over year to $5.1 billion. Reflecting the accelerated sales from bank channel and WAYS product but partially offset by weak average yen, premium income from the Japanese operations, in terms of dollars, was up 9.6% year over year to $4.4 billion in the reported quarter.
Net investment income from the Japanese operations climbed 2.7% year over year to $731 million. The growth was primarily mitigated by a weak yen/dollar exchange rate, which was 78.64, or 1.1% weaker than the average rate of 77.78 in the year-ago quarter. However, higher benefit ratio, weak yen and other expenses resulted in pre-tax operating earnings in Japan of $994 million, dipping 2.5% over the prior-year quarter.
Aflac U.S. generated revenues of $1.4 billion, up 5.2% over the prior-year quarter. Net investment income saw an uptick of 3.5% year over year to $153 million. Premiums from the U.S. operations were up 5.2% year over year to $1.3 billion. Given the lingering weakness in the U.S. and limited growth in new sales, total new annualized sales slipped 1.5% year over year to $335 million as more than 90% of the accounts come from the small business market.
Subsequently, pre-tax operating earnings in the U.S. spiked 21.5% year over year to $260 million, while persistency improved to 76.9% from 75.9% in the year-ago quarter.
Financial Update
As of September 30, 2012, total investment and cash were $124.2 billion compared with $103.46 billion at 2011-end, while shareholders' equity totaled $16.0 billion as against $13.50 billion during the same comparable period. Shareholders' equity per share was $34.10 at the end of the reported quarter, up from $27.76 per share reported at the end of 2011 and $30.29 per share in the prior quarter.
At the end of the reported quarter, Aflac projected its risk-based capital ratio in the range of 575–600%, compared with 493% at 2011-end, while its solvency ratio in Japan is also at the higher end of 500–600% target. During the reported quarter, net unrealized gain on investment securities and derivatives were $2.3 billion as compared with $1.5 billion in the prior quarter.
Meanwhile, annualized return on average shareholders’ equity for the reported quarter was 27.0% against 13.9% in the prior quarter. On an operating basis (excluding realized investment losses and the impact of ASC 815 on net earnings, and unrealized investment gains/losses in shareholders' equity) Aflac’s return on average shareholders’ equity came in at 25.2%, up from 24.0% in the previous quarter.
Guidance
Concurrent with the release of third quarter’s result, Aflac revised its 2012 outlook. The company expects revenues from Aflac Japan to increase about 30–35% in 2012, way higher than the prior forecast of 10%. The revenue projection for Aflac U.S. is expected to be flat over 2011, lower than the prior estimate of 3–8% growth. Annual premium sales are expected to be within 22–25% in 2012, while new annualized sales are projected to grow by 0–5% in the second half of 2012, reflecting difficult comps. While management expects sales to improve going ahead, as the majority of the enrolments are scheduled to occur during the fourth quarter, reduction in the discounted advance premium rate, which was effective on October 22, 2012, could pose challenges.
Additionally, management reaffirmed its earnings guidance for 2012 in the range of 3–6% over 2011, excluding the effect of foreign currency fluctuations. This also reflects the impact of new accounting for deferred acquisition cost (DAC) by approximately 5 cents per share and portfolio derisking.
Accordingly, if the yen averages 80 against dollar, the earnings growth is expected to be within $6.58–6.63 per share for 2012, higher than the prior band of $6.45–6.52 per share based on low annual effective tax rate.
Based on this exchange rate assumption, management provided its fourth quarter earnings expectation in the range of $1.46–1.51 per share. Additionally, total revenue is anticipated in the band of 0–15%. Management also plans to repurchase shares worth $100 million in the upcoming quarter.
Excluding currency fluctuations, Aflac anticipates the earnings growth to improve by 4–7% in 2013.
Dividend Update
Concurrently, the board of Aflac announced a 6.1% hike in its regular cash dividend to 35 cents from the prior 33 cents per share, which is payable on December 3, 2012 to its shareholders of record as on November 14, 2012. This marks the 30th consecutive year of dividend raise. Last October, the company had hiked its dividend by 10% to 33 cents.
Earlier, on September 4, 2012, Aflac paid a dividend of 33 cents per share to its shareholders of record as on August 15, 2012.
Our Take
Over the years, Aflac has been significantly focusing on strengthening its insurance operations through successful product launches and the expansion of its distribution system, which has been significantly contributing to its strong sales results. This has also enabled the company to generate healthy capital ratios and cash position, while raising dividends from time to time. However, higher operating expenses continue to be a deterrent for desired advancement.
However, the near-term outlook remains cautious, given the effect of portfolio derisking activities and the continued low-interest-rate environment in Japan, which is also reflected in the company’s guidance. Yet, we believe that Aflac will gather momentum with the improvement in economy in the long-term, negating interest and currency risk, thereby providing more profitable investment opportunities to Aflac. Going ahead, the company’s strong capital and surplus cash position is expected to mitigate balance sheet risks and provide liquidity cushion as well as return value to shareholders consistently.
Hence, we continue to retain our Neutral stance on the stock, with a Zacks Rank #3, implying a short-term Hold rating. Meanwhile, Aflac’s peer Unum Group (UNM) is slated to release its results after the closing bell on October 31, 2012.
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