Quacks Like a Duck, Flies Like an Eagle

04/28/2011 3:33 pm EST

Focus: STOCKS

James Stack

President, Stack Financial Management

The insurance provider’s shares are entirely too cheap, given the insurer’s tendency to grow earnings by double digits, writes James Stack of InvesTech Research.

Aflac (AFL), a provider of supplemental insurance, has significant operations throughout Japan—including the quake-devastated Tohoku area. Although the earthquake has caused a humanitarian crisis for the Japanese people, the financial consequences for Aflac look to be only minor at this point.

Although Aflac receives more than 70% of its total revenue from Japan, less than 5% of its Japanese sales and premiums come from the hardest-hit areas. The company will see immediate effects in its Life and Medical insurance lines as claims come in from those devastated by this tragedy.

However, management has been very clear that it does not foresee a major impact on earnings from these claims. As a result, company executives are maintaining 2011 guidance of 8% to 12% operating-income growth, although they have noted that the low end is now more likely than the high end.

Looking at Aflac’s history, we see some similarities between the current situation and the 1995 Kobe earthquake, which had little effect on the company. Although the current quake is larger in scope, the Kobe quake claimed nearly 6,000 lives. Despite this significant loss of life, Aflac saw no discernable impact on earnings.

The caveat—and this is something management has been very forthright about—is the long-term cancer implications. Cancer insurance makes up nearly 50% of Aflac’s Japanese premium base. As of today, we simply do not know if the nuclear issues will cause repercussions in cancer trends down the road.

We do, however, know that any change in cancer rates will take years to develop, and the present value of such an event will likely be minimal.

Today, shares trade at only 9.5 times earnings—an attractive valuation for a company with a unique business model that generally grows earnings at a double-digit pace. [This is still true following the stock’s 5% gain today, after quarterly results beat expectations—Editor.]

As the situation in Japan continues to unfold, we will closely monitor the impacts. Right now, however, Aflac’s valuation, earnings power, and financial strength all continue to make it an attractive risk/reward opportunity.

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