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Can Aflac Keep Quacking Loud Enough?

Aaron Levitt Aug 22, 2016


Aflac (AFL ) is famous for two things. One is the duck. The other, more pertinent to dividend investors, is that it’s only one of two insurance agencies on the S&P 500 Dividend Aristocrats Index (SPDAUDP). For income seekers, the index of firms with long histories of dividend increases is often a fertile hunting ground and the first stop when selecting new investments. As a result, Aflac is often cited as a great buy for investors.


And, for the most part, that’s true.

However, there are a few glaring issues that investors should consider before snatching up shares of the “hurt & miss work” insurer. Those issues can be overcome. But the question is whether Aflac can quack loud enough to do just that.


Aflac’s History


Aflac didn’t become a household name until the 2000s, when it introduced its spokesman. However, the firm has been offering insurance products since the 1950s. Today, its biggest product offering is its supplemental line of insurance policies. These are the well-known policies that pay cash to help with unexpected out-of-pocket costs and pay bills while sick or injured. These policies continue to be a cash cow for Aflac, since most policyholders never use them.

The firm is also a provider of life, cancer, dental, vision, critical illness and hospital insurance. Again, these types of policies come with pretty substantial underwriting profits as they often go unused.

The problem for Aflac isn’t the policies themselves, as they clearly help generate decent returns for the insurance agency. The issue is, well, where they issue them.

When AFL was looking to expand, the firm was one of the first insurers to look towards Japan as an option. This was during the 1970s and at the beginning of Japan’s post-war expansionary period. In order to make its mark, Aflac copied the business model it used here at home. Namely, it would sell its products at the worksite and through payroll deductions. The company signed some 40,000 or so agreements with many of Japan’s largest firms.

Having its foothold in companies like Sony (SNR ), Toyota (TM ), Mitsubish (MSHBY)i, and Japan’s Post Office allowed it to write plenty of policies and realize some rapid growth. As a result, more than 70% of AFL’s revenue comes from the Japanese market. The other 30% comes from the U.S.


… Causes Today’s Headaches


The issue for Aflac now is that same hefty focus on Japan.

For starters, the firm’s reliance on Japanese workers could take its toll. Japan is facing one heck of a demographics crisis. Its birthrate is one of the lowest in the world. In fact, statisticians estimate that by 2020, Japanese citizens will buy more adult diapers than those made for babies. Fewer people in the workforce mean fewer people to write policies for. As for those policies, the bulk of them are cancer-related. Cancer is already the number one cause of death in Japan. With its population rapidly aging, cancer incidences are also on the rise.

So Japan’s population demographics are already a huge headache for AFL. However, the focus on Japan is hurting Aflac in another way – the weakening yen. In an effort to keep its economy moving, the Bank of Japan continues to devalue the yen, which causes Aflac to reduce its Japanese earnings/cash flows when converting them back to dollars. This creates a nasty headwind when investors try to evaluate the stock.


Can Aflac Overcome These Problems?


The question for investors is whether AFL can overcome its potential issues in Japan.

In the short term, the answer may be yes. Sales growth in Japan for cancer policies continues to be swift. Much of that swiftness comes from a new policy that allows previously diagnosed patients, who have been cancer free for five years, to apply. The firm has also stepped-up its life insurance offerings in the nation. Management expects sales growth of 4% to 6% from Japan this year.

However, to survive longer term, it must diversify away from Japan.

The United States may provide some growth. The Affordable Care Act has pushed new consumers Aflac’s way into products such as vision and dental insurance. Additionally, with high-cost HSAs becoming the standard health plan, many individuals are seeking its disaster/out-of-pocket plans. Again, this may not be enough to really move the needle away from AFL’s Japanese ills.

What’s at stake is AFL’s 33 years’ worth of dividend growth and future cash flows. If Japan becomes too much of a problem, then Aflac and its shareholders could be in trouble.


The Bottom Line


Aflac is a very well-run insurance firm. It has a long history of writing profitable policies, which, in turn, have boosted cash flows and dividends. Nevertheless, the firm’s potential problems that are looming in Japan over the long haul may want to give investors pause. It will need to address its heavy reliance on Japan sooner than later. And yet so far, all it’s done is to go further into the nation. That’s something to think about when buying shares today.

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