You would think that a 30% return over one year would result in shareholders jumping for joy. However, that doesn't seem to be the case with Aflac (AFL +0.88%) in 2013, where its investors have been worried every step of the way. Three-quarters of the insurer's business is generated in Japan, so it's not a surprise that shareholders are fretting over a continuing decline in Yen-to-dollar exchange rate, right?
Wrong. Foreign exchange rates are a non-issue with Aflac, and you'll shortly see why.
Fears over a declining Yen: a red-herring
Source: oanda.com
It's true that the exchange rates affect GAAP earnings. Indeed, as-reported financial statements must be converted into one currency. However, in the case of Aflac, that's an accounting issue -- not a financial one. The company exchanges very few yen for dollars. Effectively, the company runs two businesses, one in the U.S. and one in Japan. A key statement from the company's most recent earnings release :
However, except for certain transactions that include the Aflac Japan dollar investment program, the company does not actually convert yen into dollars. As a result, Aflac views foreign currency as a financial reporting issue and not as an economic event for the company or its shareholders.
But what about the fact that Aflac pays all dividends in dollars? Doesn't that require JPY/USD exchange given 77% of the business comes from Japan?
Nope. That's not an issue, either.
In 2012 and 2013, cash dividend payments to shareholders totaled $603 and $635 million, respectively. Aflac's U.S. operations alone earned $1.01 and $1.04 billion over the same period, easily covering the payout. In addition, the Aflac stateside balance sheet contains another $12 billion in cash.
Ignore the exchange rates and focus on the business
Aflac adds luster to its investment appeal given a niche business model. The company primarily sells supplemental insurance: providing cash to policyholders when they cannot work or otherwise qualify under certain medical conditions. This model has proven to be highly durable and ratable. The "Benefit Ratio" (benefits paid divided by premiums collected) is steady year-in-and-year-out: hovering about 68%.
Most other similarly situated insurers deal with property insurance policies, too. Casualty insurance models are unlike Aflac's supplemental insurance approach. Travellers Corp (TRV +0.13%) and Allstate (ALL +1.13%) are comparable to Aflac by market cap, but have benefits ratios that may fluctuate up or down by over 10 points year-over-year.
Aflac has yet another advantage: a strong Japanese presence. The Japanese people are the most highly insured in the world. They also tend to be very loyal customers. Aflac Japan operations boast a "Persistency Ratio" (an insurance renewal ratio indicator) that runs consistently around 95%.
Travellers and Allstate can't touch that. Even Aflac must settle for a 78% U.S. persistency ratio despite its niche business model and little direct competition.
The benefits of this niche are clear. Looking at 5-year growth rates compared to its peers, Aflac is clearly ahead of the pack, boasting the top earnings and revenue growth rates along with a healthy rise in dividends paid.
| Aflac | Travelers | Allstate | |
|---|---|---|---|
| Market Cap ($B) | $29.1 | $29.5 | $24.2 |
| 5-yr EPS Growth Rate | 20.9% | 15.1% | NMF |
| 5-yr Revenue Growth Rate | 7.7% | 1.4% | 3.3% |
| 5-yr Dividend Growth Rate | 8.1% | 15.3% | -10% |
Source: Company financials.
With little to worry about the always-unpredictable exchange rate, the only people who should be fretting over Alfac are those who haven't gotten in.
