NEW YORK (TheStreet) -- As someone who came into the investment business in 1980, I was immediately enamored by the logic of Sir John Templeton. He was the founder and portfolio manager during the first 40 years of the Templeton Growth Fund.
During his tenure the fund beat the S&P 500 Index by 2% per year, net of annual expenses. We believe his best concept as a contrarian investor was his idea of buying common stocks at "the point of maximum pessimism.” In other words, he looked for meritorious common stocks among those that are contentious. He also took contentiousness one step further when he said, “If you wait to see the light at the end of the tunnel, you have already missed the bottom."
So what would Sir John think of Aflac (AFL)?
Aflac is largest seller and underwriter of supplemental health insurance. It is also the leading issuer of individual insurance policies in Japan. The price of common shares plummeted in the financial crisis of 2007-09 to $11.49 per share and now hovers around $59, down 12% for the year to date.
The shares then took a beating in the European debt crisis of 2011 as Aflac had a small but meaningful position in its bond portfolio in Portugal, Ireland, Greece and Spain. The losses taken on those bonds led Aflac’s stock to fall in price to $31.46 per share. After recovering in 2012, the shares have been bypassed by the U.S. market’s performance in recent years, despite the fact that is has increased in price from 49 cents to around $59 per share over the last 30 years. This seems very cheap to us when you consider analysts expected earnings of $6.24 per share this year.
There are three difficult business factors associated with Aflac that lead it to have a P/E ratio below 10 on consensus 2014 earnings. First, the Japanese yen has weakened in the last couple of years from 80 per dollar to about 102. The Japanese government has made it very clear that they would like to see the weakness continue. Since Aflac earns 74% of its profit from Japan, currency weakness reduces profitability.
Second, the implementation of the Affordable Care Act in the U.S. has made small to medium size businesses both leery and distracted, which has made sales comps difficult. Aflac has also had a difficult time translating its fantastic branding into strong growth in the U.S. Lastly, Aflac owns a huge investment portfolio heavily invested in bonds designed to match maturities with future insurance liabilities.
In the recent second-quarter earnings call, the top executives of Aflac gave no indication they can see the light at the end of the tunnel on yen weakness relative to the U.S. dollar. We at Smead Capital believe that the U.S. dollar is massively undervalued in relation to other currencies of developed economies, as the yen was before 2013. The Japanese leaders have been one of the first countries to realize and deal with this fact.
Aflac executives have consistently been frustrated by the company's inability to translate fantastic, wide-moat branding in the U.S. into increased sales of its supplemental health insurance in the U.S. Officials said on the earnings call that second-half earnings will be negatively impacted by the expense of gearing up U.S. sales efforts (no light at the end of that initiative’s tunnel).
In a world of low interest rates, international turmoil and potential default of countries like Argentina, risks abound in the bond market. Aflac hired Eric Kirsch from Goldman Sachs in 2011 to oversee the investment portfolio and every indication is that it is no longer an area of grief for the company. However, low interest rates overall make it harder to make money on the float created by premiums.
Here is how Smead Capital puts all of these circumstances together: Aflac has a great history of profitability, consistently gorgeous free cash flow and has generated huge wealth for the public shareholders. Still, current business negatives, which successful solutions are unknowable and unseen, cause most investors to avoid shares of the company.
To us, this sounds like a prescription to which Sir John Templeton might be attracted if he were still investing.
At the time of publication, the author was long Aflac through his ownership of the Smead Value Fund, although positions may change at any time.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.
TheStreet Ratings team rates AFLAC INC as a Buy with a ratings score of A-. TheStreet Ratings Team has this to say about their recommendation:
"We rate AFLAC INC (AFL) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its largely solid financial position with reasonable debt levels by most measures, attractive valuation levels and notable return on equity. We feel these strengths outweigh the fact that the company has had sub par growth in net income."
Highlights from the analysis by TheStreet Ratings Team goes as follows:
- Although AFL's debt-to-equity ratio of 0.28 is very low, it is currently higher than that of the industry average.
- AFL, with its decline in revenue, underperformed when compared the industry average of 11.6%. Since the same quarter one year prior, revenues slightly dropped by 3.4%. Weakness in the company's revenue seems to have hurt the bottom line, decreasing earnings per share.
- Current return on equity is lower than its ROE from the same quarter one year prior. This is a clear sign of weakness within the company. Compared to other companies in the Insurance industry and the overall market, AFLAC INC's return on equity exceeds that of both the industry average and the S&P 500.
- AFLAC INC's earnings per share declined by 6.3% in the most recent quarter compared to the same quarter a year ago. This company has reported somewhat volatile earnings recently. We feel it is likely to report a decline in earnings in the coming year. During the past fiscal year, AFLAC INC increased its bottom line by earning $6.75 versus $6.11 in the prior year. For the next year, the market is expecting a contraction of 7.5% in earnings ($6.25 versus $6.75).
- You can view the full analysis from the report here: AFL Ratings Report