SPY - Aflac Q3: Why High Valuation May Be Signaling A Stock Split (Rating Upgrade)

2023-12-05 08:00:00 ET

Summary

• Aflac's stock price has risen nearly 10% in the past two months, outperforming the market despite volatility.
• The company's strong performance and growth in earnings, revenue, and share repurchases make it a prime candidate for a stock split.
• Share buybacks and a recent dividend increase further support the possibility of a stock split in the near future.
• Despite a strong 2023, the company still faces risks from a weakening yen and a potential raise in rates in 2024.
• Fed Chair Jerome Powell recently pushed back against rate cut talks stating it was too soon to speculate.

Introduction

I last wrote on Aflac ( AFL ) roughly two months ago where I rated the stock a hold because it had experienced a decent run up in share price and holding steady around $75 at the time. Since then, the price has continued even higher and is now trading near $83 a share, a near 10% gain in 2 months. This is impressive as many stocks and sectors have experienced a lot of volatility during this time. I started buying AFL when it was trading at $59 a share, so I have made some nice capital gains on the stock since holding. I've mentioned how the market is forward-looking and sometimes a stock's share price can tell us something. This may be good, bad, or indifferent. But in this article, I take a look at why a stock-split may be in the works for Aflac.

Why A Stock Split Could Be In The Works

September and October are historically the worst months for the stock market. Looking here the SPDR S&P 500 ETF ( SPY ) was down over 7% while AFL was up over 4% in the same period. Fellow analyst, Logan Kane, touched on this in an article published back in September. In it he described and gave reasons why September & October generally combine for negative average returns.

From the 1st of September until the end of October AFL was up 4.47% while the SPY was down 7.31%. Since March, AFL's price has surged over 35% as you can see in the chart below.

Insurance stocks are normally strong performers during times of uncertainty and I addressed this in my earlier articles on Aflac and Old Republic ( ORI ). As you can see here AFL also outperformed its peers by a wide margin.

So, could Mr. Market be letting us know that the company plans to split its stock soon? Aflac last split its stock nearly 6 years ago back in March of 2018. The stock's price ranged from $70 to $91 during the year prior. Management decided to do a 2-for-1 stock split and the share price rose to over $86 shortly after. During the last split their CEO stated that shares would have to hold in the range of $75 or higher for six months before the board would consider doing a split.

After the announcement the shares traded at $43 apiece. Since July, shares have held above $70 and continued higher trading slightly below their 52-week high of $83.45. I'm not saying it will happen again just because their CEO stated this before the last split. But I do think the market is pricing in the possibility and that's why the stock continues to soar. I've honestly been waiting to add to my position for a while but have continued to hold due to the share price. AFL's outperformance in the current macro environment, during a time when several high-quality businesses are facing pressures, is a testament to their financial strength and resilience.

Strong 2023 Performance

AFL reported Q3 earnings back in November and the stock beat analysts' estimates on the top and bottom lines by a large margin. EPS of $1.85 surpassed the average of $1.49 while revenue of $4.95 billion beat the $4.45 billion consensus. While 2023 has continued to place downward pressure on several companies' earnings, Aflac has been breezing past estimates this year.

In the chart above you can see AFL's outperformance in earnings and revenue this year. In Q1 & Q2 they also surpassed analysts' estimates on both earnings and revenue as well. So, in short AFL's outperformance on earnings & revenue has also been reflected in the share price. 2023 hasn't been a good year for many companies so to have an outperformance like this shows not only the quality of the business, but the resilience as well. One other reason why the stock may be primed for a stock split in my opinion.

Something else the company has been able to do this year is impressively grow their book value per share. From Q1 to Q2, AFL's book value increased 4.36% and nearly 4% in Q3. AFL's strong year was supported by a 12.4% increase in sales in Japan year-over-year. This was driven by a near 23% increase in cancer insurance sales in the country.

In the U.S, sales were lower but still impressive at 7.5% during the quarter. So, all in all AFL has had a strong year and I expect this to continue for the foreseeable future. No matter how tough times are or what's going on in the economy, one thing most of us will have is insurance. As a newly retired (Nov 1st) military retiree, if I would like to keep my life insurance I'll now have to start paying for it.

Share Buybacks Support The Split

Companies who repurchase a large amount of its shares are good candidates in my opinion for stock splits. I'm not saying every company that does will split their stock, I'm just saying they have an increased likelihood of doing so. Unlike BDCs and REITs, who conduct share offerings, companies like AFL tend to buy back their shares which usually increases earnings over time and increases shareholder ownership. And if they pay a dividend on top of buybacks, that's a plus.

There are companies that buyback a large number of their shares that don't have a long history of stock-splits or pay a dividend. One example is AutoZone ( AZO ). They have bought back a large number of shares over the years but haven't split their stock since the early 90's. Unlike Aflac, who has a pretty solid history of stock-splits. And if they decided on another in the foreseeable future it would mark the 11th split in company's history.

Since 2018, AFL's last split, the company has repurchased a significant amount of shares. As an investor, especially one who invests for income, a decreasing share count is something nice to see. This is an additional way companies return cash to its shareholders.

During Q3 earnings their CEO stated:

I am even more pleased with the Board's action to increase the first quarter of 2024's dividend by 19% to $0.50 per share. We also remain in the market repurchasing shares at a historically high level of $700 million, as seen in the first two quarters of this year. We intend to continue prudently managing our liquidity and capital to preserve the strength of our capital and cash flows, which support both our dividend track record and tactical share repurchases.

Most know the stock conducted a large dividend increase earlier but this increase was larger than normal besides 2022's increase. It could also be just because the company has had a strong year but a $0.02 increase is usually the norm for Aflac. But with a $0.50 dividend, conducting another 2-for-1 stock split would still make it attractive for dividend investors. Just food for thought. In 2013, AFL had over 900 million shares outstanding. If the company continues repurchasing its shares at a rapid pace, then conducting a stock-split would put the share count near the same amount as a decade ago.

Valuation

Seeing as how the price has increased in the last year, it's no surprise the stock is considered overvalued. Quant gives them a valuation grade of D as they currently trade above the sector median and their 5-year average P/E. Most analysts also rate them a hold currently and I think it's due to the run up in price. Currently, the stock's price target is lower than the current share price so it offers investors no margin of safety.

But if the market is thinking of a potential split, I don't see the price coming down anytime soon. I expect them to trade within the $80-$85 range until then. And if a stock split is announced, I see the price going even higher as splits by blue-chip companies are often considered bullish. Additionally, splits can lead to a runway for future growth and often renew investor interest, leading to an increase in share price over time.

As seen here the blue-chip retailer Walmart ( WMT ) conducted several 2-for-1 stock splits during the early 70's to late 90's and saw its share price continually increase due to renewed investor interest. So, for investors looking to start a position, if you believe the stock could split then this may be a good time to buy. I actually sold some shares to take profits, adding to my undervalued REIT positions a few weeks back. But I'm seriously considering add to Aflac as I believe a stock split is near.

Risk Factors

Aflac and many insurance companies are considered to be resilient businesses. But even so they are not without risk. One huge risk for the company is the weakening yen. Management addressed this and has been taking proactive steps against this by preserving liquidity. And although many expect rates to be cut in the coming year (myself included), consumer spending continues to be tight for many. If rates are held for longer as the Fed has stated, or even increased, this could impact AFL's financials going forward. Although they've had a very strong 2023, next year could look different.

Fed chair, Jerome Powell, recently pushed back against rate cut talks saying it was too soon to speculate. But said they will continue to move carefully and future rate hikes will be dependent on incoming data in the coming months. But in my opinion, I expect them to hold for the foreseeable future and cut sometime around the 2nd half of '24.

Bottom Line

Aflac has had a very strong 2023 as seen by its share price movement, even outperforming the SPY and all of its peers. And since insurance companies are considered stable, high-quality businesses, I suspect a stock-split could be in the company's near future. And I think the current share price reflects this. This is all speculation as I have no way of knowing nor do I know if it will happen. But with the company's outperformance vs peers, 19% dividend increase, and historical high share repurchases during the year, I think they are a prime candidate for a 2-for-1 stock split.

If you hold a position in the company now may be a good time to add. Even with the run up in price, the stock still trades at only 13x earnings. For those who've been waiting but haven't bought because of the high valuation, you may get your chance if the stock does split in the foreseeable future. Because I think a split may be coming, I now rate the stock a buy.

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