Aflac’s Incredibly Safe Divide – GuruFocus.com

Insurance companies are often considered boring, slow-growth investments, but there has been nothing boring about Aflac Inc.’s (AFL, Financial) last few dividend increases. Shareholders received a 21.2% raise for the upcoming March 1 payment, which followed an 18% increase in the prior year.

Aflac can afford to provide such high-level increases because the company’s dividend is well protected on a variety of metrics. We will examine several that show the company’s dividend might be one of the safest in the market.

Company background and results history

Aflac was founded in the mid-1950s and grown to become a leading underwriter of accident, cancer, short-term disability and life insurance. The $41 billion company operates in just two countries, Japan and the U.S., with the former contributing more than two-thirds of annual earnings.

Aflac reported fourth-quarter and full-year earnings results on Feb. 2. For the quarter, revenue fell 8.1% to $5.4 billion, but beat Wall Street analysts’ estimates by $193 million. Adjusting for investment gains, earnings per share improved 26 cents to $1.33.

For 2021, revenue fell slightly by 0.2% to $22.1 billion, but adjusted earnings per share improved to $6 from $4.96 in the prior year.

Aflac’s earnings per share have a compound annual growth rate of 15.2% and 8.3% over the last five- and 10-year periods of time, respectively. This is an excellent growth rate for an insurance company.

Some of this growth is due to a sizable reduction in the share count. The company has repurchased 4.4% annually of the share count since 2017 and 3.9% since 2012.

This isn’t the whole story, however, as net profit has more than doubled over the last decade and has a CAGR of 12.3% over the last five years. Book value per share has increased from $17.08 in 2012 and $31.50 in 2017 to more than $52 today.

Aflac currently yields 2.5%, which is almost a full percentage point better than the average yield of 1.4% for the S&P 500 Index. This is also ahead of the stock’s 10-year average yield of 2.2%.

Dividend history and recession performance

Aflac has leveraged this long-term success into 40 consecutive years of dividend growth, earning the company the title of Dividend Aristocrat.

This dividend growth streak covers several significant recessions as customers tend to keep their insurance to protect themselves even when economic conditions worsen.

Listed below are Aflac’s adjusted earnings per share results before, during and after the last recession:

• 2006 adjusted earnings per share: $1.43
• 2007 adjusted earnings per share: $1.64 (14.7% increase)
• 2008 adjusted earnings per share: $1.31 (20.1% decrease)
• 2009 adjusted earnings per share: $1.96 (49.6% increase)
• 2010 adjusted earnings per share: $2.57 (31.1% increase)
• 2011 adjusted earnings per share: $2.09 (18.7% decrease)
• 2012 adjusted earnings per share: $2.93 (40.2% increase)

Aflac wasn’t completely immune to the Great Recession as earnings per share declined more than 20% in 2008. The company, however, returned to growth the very next year, making a new high for adjusted earnings per share the very next year. Aflac’s dividend also continued to grow during this period with shareholders seeing a 40% increase from 2007 through 2009.

These results show the strength of the company even under duress. The company also performed admirably during the worst of Covid-19 crisis. Excluding a tax release benefit, adjusted earnings per share improved nearly 12% from 2019 to 2020.

Strong performance during these periods of time, coupled with the company’s track record of dividend growth, shows Aflac is able to grow its distributions even in challenging circumstances. The reason the company can do this is that its payout ratios are very low and its debt obligations don’t have a material impact on its ability to pay its dividend.

Dividend growth and payout ratios

Aflac’s dividend growth has a CAGR of almost 11% over the past five years as the size of the increase has accelerated over the past two years. That said, the growth rate over the long term is also solid at 8% over the last decade.

Shareholders are likely to see higher growth in the coming years because of how safe Aflac’s dividend appears.

Aflac paid out $1.32 of dividends per share last year, resulting in a payout ratio of just 22%. This is in line with the 10-year average payout ratio of 24%. The company’s payout ratio has been in a very tight range of 22% to 26% over this period of time. This is a very consistent range, making Aflac’s payout ratio almost predictable.

Free cash flow shows much of the same.

Aflac has not released cash flow figures for the fourth quarter, but for the first nine months of 2021, the company distributed $647 million of dividends. Free cash flow for this period was $4.18 billion, equating to a free cash flow payout ratio of 15.5%. While on the low side, this payout ratio is slightly higher than the three-year average payout ratio of 13.4%.

Using either earnings or free cash flow, Aflac has substantial coverage for its dividend. The part shareholders should find very attractive is that the growth rates are well within the long-term average even as dividend growth has been in the high double-digits over the last two years. That could mean that these types of raises could become more of the norm.

The impact of debt of dividend security

The last metric I like to use to judge dividend safety is the impact the company’s debt has on its ability to continue to pay distributions.

Again, Aflac hasn’t issued complete figures for certain items, interest expense being one. Interest expense totaled $181 million for the first three quarters of 2021. With total debt standing at just under $8 billion, Aflac has a weighted average net interest rate of 3% as a result.

The image below shows how high the blended interest rate would have to increase before dividends would no longer be covered by free cash flow.

Source: Author’s calculations

As you can see, Aflac’s average interest rate would need to reach above 61.4% before the dividend was no longer covered by the company’s free cash flow. Therefore, it is highly unlikely that debt obligations would make any impact on Aflac’s ability to continue to pay its dividend. In fact, it can be argued that interest expense won’t be much of a factor at all even if the company continues to aggressively raise its dividend.

Final thoughts

Aflac operates a very sound business model that has worked in nearly every type of market. It is why the company’s growth rates have been very good for a long period of time and why the Great Recession and Covid-19 barely impacted the business at all.

Because of this, Aflac has managed to raise its dividend for four decades, with the last two raises being amongst the most generous in the company’s history. The stock’s yield is superior to both its own history and to that of the market. Just as important, the earnings and free cash flow payout ratios are incredibly low and debt expense is very reasonable.

This suggests that those who are looking for a solid yielding stock offering a very safe dividend consider purchasing shares of Aflac.