2023-10-04 09:00:00 ET
Summary
- Aflac has seen its price appreciate almost 36% in the last year offering investors little upside to its price target.
- If the economy enters into a recession, AFL could face downward pressure on its policies due to consumers' ability to maintain or purchase additional coverage.
- AFL has an impressive dividend growth streak and a low payout ratio of 26%.
- Aflac offers a low yield but has seen its price appreciate, unlike some low-yielding stocks, whose prices have declined due to current treasury rates.
Introduction
As the world awaits the FED's decision on whether they continue raising rates or hold them here and start to cut later, the market continues to react unkindly. In the last month, the S&P is down 3.5% and some sectors are down even more. Some investors might've noticed a lot of the lower-yielding stocks are down, like REITs, while others like BDCs are up. That's because they currently offer much better yields than REITs right now. Treasuries are also offering better rates, so investors are placing their money in safer alternatives. Even normally rock-solid consumer staple stocks that hold up well during times of uncertainty like Coca-Cola (KO) and Pepsi (PEP) are down too. So why hasn't Aflac (AFL) who has a 5-year average dividend yield of 2.46% dropped in price during all of this? In the last year, AFL is up almost 36% and almost 20% in the last 6 months. In this article, we'll dive into why the stock has held strong during the current macro environment.
Business Overview
Aflac has a strong underlying business model. Most of us know the company sells insurance. They provide supplemental health & life insurance policies and operate in two of the largest insurance markets in the world, Japan & U.S. The company was founded almost 7 decades ago in 1955 and is headquartered not too far from my hometown in Columbus, Georgia. I actually have a few family members that worked for AFL, and can attest they were a great company to work for.
Aflac U.S. is the No. 1 provider of supplemental health insurance. In Japan, Aflac is the leading cancer & medical policy provider in force. In the U.S. they offer short-term disability, accident, cancer, critical illness, dental & vision, etc. The company develops relevant supplemental insurance products and sells them through expanded distribution channels. They also recently added medical insurance for pets that covers accidents, illnesses, and treatments.
Industry Performance Vs. Market
As previously mentioned in my article I recently wrote on Old Republic International, another type of insurance company, these are typically boring, yet some of the most stable businesses in the world. When you think about it, everyone needs or pays for some type of insurance in their lives. Businesses need it for compliance & liability reasons, and we need it as well. Whether it be life insurance, car insurance, or even insurance on our precious cell phones. Insurance is something you read, see, and hear about all the time, yet their businesses or stocks don't get the attention as those such as Apple (AAPL) or Tesla (TSLA).
As you can see below, the insurance industry, although boring, essentially outperforms the broader market over a 3-year period, and is in-line over a 1 & 5-year period. AFL significantly outperforms the market over a 1, 3, & 5-year period. When you include dividends, AFL's 3 and 5-year performance increases roughly 20% to 124% and 86.5% respectively, compared to the market's 26% and 59% over the same period.
Recent Earnings & Past Performance
During Q2 earnings Aflac reported strong earnings for both the quarter and the first half of 2023. E.P.S. came in well above analysts' expectations at $1.58, beating by $0.14. They also beat on revenue estimates with $5.17 billion in the quarter, compared to the $4.47 billion estimate from analysts.
So the company has had a strong year in 2023. Revenue was up 7% from Q1, but down year-over-year by almost 3%. One reason for the strong growth was the 26.6% new sales premium increase in Japan, reflecting a 60% increase in cancer insurance sales year-over-year as well.
But those unfamiliar with the insurer should not be surprised, as AFL has not only performed well in '23, but over the last decade as well. Since 2013 earnings per share have increased 72.5% in 2022, and that number is expected to increase roughly another 20% to $6.04 by the end of this year according to SA. My guess is that AFL will continue to exceed expectations and beat end-of-year estimates. In the first half, the insurer reported EPS of $3.13, an 8.6% increase from 1H '22 EPS of $2.88. As you can see below, AFL saw a significant increase in earnings in 2020 & 2021 thanks to the pandemic.
Safe Dividend Plus Growth
Aflac has a total of 40 years of dividend growth, making it a dividend aristocrat. And the way the business is growing, I don't see any reason why it won't become a dividend king in the next decade. The company grew the dividend from 2001 to 2018 from $0.05 to $0.52 before the last stock split in 2018. In the last 5 years, they have grown the by dividend 61.5%. Seeking Alpha gives the company an A+ in consistency and a grade of B for dividend safety. In my opinion, the insurer deserves an A+ as it has a low payout ratio of just 26.5%.
Additionally, the company also has a low cash flow payout ratio as well. Although it makes more sense to measure an insurance company's earnings, AFL has been retaining plenty of cash flow. This means the company can readily invest in business endeavors to continue to grow the company. Cash flows can be highly volatile for insurers, since they typically don't make capital expenditures like other businesses. This has also allowed the company to buy back its shares over the last decade. So not only have they grown the dividend, they've also returned plenty of cash to its shareholders via buybacks.
Valuation
I started buying AFL when it hit its 52-week low of $56. The stock has since taken off and been hovering between $74-$76 for some months now. The stock recently hit a new 52-week high of $78, but has since come down slightly. Because of so much economic uncertainty over the last year, I now believe AFL is in overvalued territory. The stock was also downgraded back in August by Morgan Stanley (MS) because of the limited upside. Additionally, the dividend yield sits below their 5-year average of 2.46%.
Because of the sector's historically strong performance, many insurance companies are now overvalued in my opinion, including peers MetLife (MET) and Prudential Financial ( PRU ). As you can see, most rate the stock a hold, and I agree. They currently offer no margin of safety, and I think investors should wait for a pullback in price before adding. I've held the stock and have not added since the recent price run. Furthermore, the stock has a forward P/E of 11.1x, which means the price is expected to come down in the near future. If the economy goes into a recession, I expect the price to come down significantly, and I explain why in the next section.
Risks
One of the biggest risks AFL and its peers face is if the economy does indeed enter into a recession. During the GFC, life & premium policy growth slumped. A weaker economic environment could make it tougher for AFL to grow. During its last earnings call, management stated their growth platforms of dental & vision, group life & disability, and consumer markets are starting to have a more material impact on performance. The unemployment rate was 3.8% in August, a rise of 0.3%. A recession would most likely cause this to rise further, which could limit some individuals' capacity to maintain or purchase coverage. This would place downward pressure on policies affecting the industry as a whole.
Bottom Line
AFL is a solid business that's been around for decades. Insurance is a crucial industry, and this combined with the current macro environment has caused the stock to become overvalued. With talks of a recession seemingly more likely, the stock could see its price decline, as this could affect policyholders' ability to maintain coverage as unemployment rises. The company has enjoyed some strong earnings growth in 2023 and expects this to continue going forward. Additionally, AFL offers a safe dividend currently with a 26% payout ratio but limited upside to its price target. The stock has proven to be resilient in the last year, causing it to become overvalued, and investors looking to add should wait for any signs of share price weakness.
For further details see:
Aflac: Why This Low Yielder's Price Is Holding Steady