While no one will ever mistake it for one of the market's sexy new growth stocks, there is a lot to be said for having a stock like AFLAC Incorporated (NYSE:AFL) in a portfolio. The company pays a growing dividend, which it has now raised for 35 consecutive years, making it an esteemed member of the Dividend Aristocrats club. Aflac consistently underwrites profitable policies, as measured by its combined ratio, and invests its float, the money it collects from premiums but has yet to pay out in claims, in conservative dollar- and yen-based fixed-income securities. Despite its steady approach to growth, Aflac has beaten the S&P 500 index's returns over the trailing three-year and one-year periods.
When the company reported its first-quarter earnings late last month, there were not many surprises. Total revenues inched up to $5.46 billion, a 3% increase year over year, while adjusted EPS (formerly referred to as operating EPS by the company), jumped to $1.05, a 25% increase year over year, thanks to the newly passed tax reform.
After reading through the company's first-quarter conference call, transcribed by S&P Global Market Intelligence, three big takeaways stood out.
1. Aflac Japan disappoints
Many investors may not know that Aflac actually generates the majority of its revenue in Japan, not the U.S. In the company's first quarter, management described Aflac Japan's third sector insurance sales as "modestly weaker than our expectation." Third sector insurance generally refers to insurance policies sold to people for sickness, hospital stays, and injuries (first sector is life insurance, and second sector is property damage). Management said two factors contributed to this disappointment, both of which should be rectified by the second half of the year.
In 2017's first quarter, Aflac Japan introduced a new medical insurance product, giving this year's first quarter a tough comparable to compete against in that product category. Second, CEO Daniel Amos pointed out, the company announced it would be launching a new cancer policy update in the second quarter this year. After the company announced this, Amos said much of the country's sales team stopped pushing Aflac Japan's existing cancer policies until they could sell the new product.
After detailing these two factors, Amos concluded, "The combined effort of launching a product in the first quarter of 2017 and delaying launch of our new cancer product until April of 2018 made the challenging quarter." Amos maintained that the company still expects to meet its full-year sales goals.
2. Tax reform provides large bounty
Although investors realized that Aflac would be receiving a nice boost from the newly passed tax legislation, I think many failed to appreciate how much of a windfall it would actually provide. More than half of the company's adjusted EPS gains this quarter could be attributed to the new law. The tax law also lets management accelerate spending in areas that should help the company grow. When asked how this money was being invested, CFO Fred Crawford clarified:
We're ... spending money to jump-start the productivity of our organic distribution model in the U.S., while at the same time investing in technology that we think will develop expanded distribution opportunity. And so we have pinpointed some of those investments and accelerated it into the current period ... We've got a long-term roadmap of improving and building out our technology or modernizing our technology. And we've gone into that roadmap and specifically plucked out areas of it that drive growth to accelerate that spend. ... we want all of that spend to be hardwired towards growth.
A nice earnings boost and accelerated spending to drive growth -- a great combination for investors!
3. Rising interest rates juice growth
Finally, Aflac is one of the few companies benefiting from rising interest rates that isn't a bank. Because Aflac invests its float in fixed-income securities, interest rates directly affect its earnings. While Aflac hedges its investments against wild swings in interest rates both ways, it still realizes a net benefit when interest rates rise. Crawford said:
The quarter's [investment income] outperformance was driven by favorable results in our U.S. dollar portfolio. We were opportunistic in accelerating the growth of our floating-rate portfolio and also benefited from higher floating-rate yields relative to our expectations heading into 2018.
Steady as she goes
Again, Aflac will never show the explosive growth rates of a software-as-a-service company or hot new start-up. But it stays within its circle of competency, producing profitable underwriting policies, and faithfully makes money from its float quarter after quarter, year after year. Better yet, it sells at a nearly ridiculously low forward P/E ratio of about 12, about half of the average P/E ratio of the S&P 500. By my thinking, that makes it one of the best value stocks on the market today.
I sold my shares after allegations ranging from fraud to an isolated incident of sexual harassment were brought against the company earlier this year. The company forcefully answered those charges, though, and management said in the conference call that it had seen no signs of the charges affecting business. I have now reinitiated my bullish CAPS call on Aflac and reestablished my position.