Despite its U.S. roots, Aflac Incorporated (NYSE:AFL) has a unique corporate profile. Its accounting has confused some investors. I routinely get questions about it when discussing this insurance company's financial results.
Aflac is based in Columbus, Georgia; yet generates 75% of its business in Japan. The remainder is centered here in the U.S. Therefore, while most transactions are conducted in Japanese yen, financial statements are prepared in U.S. dollars. Currency translation can distort "as-reported" earnings significantly.
Counter-intuitively, yen-to-dollar exchange rate doesn't really matter. For Aflac, currency change is primarily an accounting exercise versus an operational one.
Let's begin with Aflac's explanatory language found in every shareholder earnings release (boldface for emphasis):
Aflac Japan's yen-denominated income statement is translated from yen into dollars using an average exchange rate for the reporting period, and the balance sheet is translated using the exchange rate at the end of the period. 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.
How can this be?
Aflac was originally founded as the American Family Life Assurance Company of Columbus, hence the acronym AFLAC. Over the years, expansion plans took the company's fortunes to Japan: its citizens are the world's most insured populous.
Since corporate headquarters remained in Georgia, the S.E.C. required the company to report financial statements in one currency: USD. Nonetheless, as a practical matter Aflac Japan business stays in Japan, and Aflac U.S. business stays in the U.S.
In 2013, physical Yen-to-Dollar fund transfers were only 8.4% of total Operating Cash Flow. Some of this exchange was for corporate management fees and allocated expenses.
Sorting through Aflac financial reports
When Aflac reports earnings, it does so 3 ways. The first 2 are fairly routine:
"As-reported," or in accordance with GAAP accounting.
"Operating Earnings," a non-GAAP measure that strips out non-core, and one-off items. This includes gains and losses from derivatives, hedging and other non-recurring events. The objective is to provide investors with a snapshot of the underlying profitability of the business.
It's the third report that savvy investors should watch for:
"Effect of Currency on Operating Results"
Here's this summary of that report from the 2014 first quarter earnings release:
Notice how a weakening Japanese yen versus the USD causes these key financial metrics to all show declines. However, when currency change is excluded, the results turn positive. Smart investors realize that since the conversion issue is primarily an accounting exercise, the real core earnings "action" is found on this document.
From the Aflac 2014 first quarter earnings release, the "as-reported" diluted earnings per share:
Reflecting the weaker yen/dollar exchange rate, total revenues fell 9.1% to $5.6 billion during the first quarter of 2014, compared with $6.2 billion in the first quarter of 2013. Net earnings were $732 million, or $1.60 per diluted share, compared with $892 million, or $1.90 per share, a year ago.
Next, the "operating earnings" report:
Finally, Aflac management explains EPS sans the currency exchange effect:
The average yen/dollar exchange rate in the first quarter of 2014 was 102.70, or 9.8% weaker than the average rate of 92.59 in the first quarter of 2013. Operating earnings in the first quarter were $774 million, compared with $790 million in the first quarter of 2013. Operating earnings per diluted share in the quarter remained unchanged from a year ago at $1.69. The weaker yen/dollar exchange rate decreased operating earnings per diluted share by $0.10 for the first quarter. Excluding the impact from the weaker yen, operating earnings per diluted share increased 5.9%.
Sure, but isn't yen currency conversion required to pay dividends?
No. But it's true all Aflac dividends are paid in greenbacks.
Currency conversion isn't required to make the payments. Indeed, Aflac U.S. operations more than cover the distributions. In 2013, this segment earned over $1 billion, while the total cash dividends were $635 million. In addition, Aflac U.S. currently holds another $12.8 billion is cash and investments. For the foreseeable future, no yen repatriation is necessary to meet the payout.