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AFLAC Incorporated (AFL): A Dividend Aristocrat Trading For Less Than 10x Earnings

Key Risks

While AFL has plenty of staying power, the business faces several challenges. Like all other insurance businesses, AFL runs the risk of mispricing its policies or facing a “black swan” event that forces it to pay out more policy benefits than expected. There’s nothing we can really do about this other than look at management’s track record, which has been excellent (policy premiums have exceeded benefit payouts for at least the last 10 years).

Insurance markets can also go through cycles of increased pricing pressure and competition. However, AFL is typically the lowest cost provider and has the financial strength and brand recognition to outlast almost all of its competitors. With a favorite holding period of “forever,” we are less concerned with this risk impacting AFL’s long-term earnings potential.

The bigger issue with AFL is Japan, where the company generated over 70% of its sales last year. The Japanese yen has declined by 30% since 2012, causing fewer dollars to be reported on AFL’s financial statements.

Furthermore, about 39% of AFL’s total portfolio of debt and perpetual securities was invested in Japanese Government Bonds (JGBs) as of 12/31/14. JGBs have extremely low interest rates and have significantly limited AFL’s investment income, which is expected to decline by 1-2% in Japan in 2016.

Since 2012, AFL has been working to improve the return and risk profile of its Japanese investment portfolio. The company also hired a new Chief Investment Officer of Aflac Japan, which will hopefully help the portfolio’s long-term returns as it attempts to move into investments outside of JGBs.

Japan’s economy faces several challenges that could cause foreign exchange and interest rate headwinds to persist. The country’s economy recently dipped into a technical recession, its population is aging, birth rates are declining, and medical treatment costs are increasing. The Japanese government is undertaking actions to try and stimulate the economy, which could have unintended consequences on Japan’s sovereign credit profile and create more volatility in Japanese capital and currency markets.

S&P and Fitch actually cut their credit ratings of Japan by one level earlier this year, citing little chance of the government’s strategy turning around the poor outlook for economic growth and inflation over the next few years.

It’s challenging to forecast how these factors could impact AFL’s earnings from Japan, but we believe AFL’s conservatism and the stock’s depressed multiple help mitigate this risk. The company will also continue seeking organic growth opportunities via channel network expansion, potential new products, and maybe even new geographies one day.

Dividend Analysis

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. AFL’s long-term dividend and fundamental data charts can all be seen by clicking here.

Dividend Safety Score

Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

AFL earned a very strong dividend Safety Score of 99, suggesting its dividend payment is very secure. The company maintains a low payout ratio, generates consistent free cash flow, is conservatively managed, and has a healthy balance sheet.

Over the last four quarters, AFL’s earnings payout ratio is 28%, providing plenty of cushion and room for future dividend growth.

Looking below, we can see that AFL’s payout ratios have remained at conservative levels over the last decade, indicating that the company’s dividend growth has been driven by solid earnings growth.

AFL EPS Payout Ratio

Source: Simply Safe Dividends

AFL Free Cash Flow Payout Ratio

Source: Simply Safe Dividends

We also like to see how companies performed during the financial crisis to gauge their sensitivity to the broader economy. AFL’s reported sales and free cash flow per share actually grew each year, and the stock outperformed the S&P 500 by about 12% during 2008. This highlights the conservative nature of AFL’s insurance and investment portfolios and the non-discretionary nature of many of its products.

AFL Sales Growth

Source: Simply Safe Dividends

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