AFLAC Incorporated (NYSE:AFL) has also maintained a high and stable return on equity over the last 10 years. As seen below, AFL’s return on equity has averaged close to 20%. AFL’s ability to invest policyholders’ premiums helps it generate high returns without needing to commit much of its own capital.
Source: Simply Safe Dividends
AFL’s capital-light business model makes it a very consistent free cash flow generator as well. We can see that the company has generated positive free cash flow in each of the last 10 years. Free cash flow generation is very important because it allows a company to comfortably reinvest and return capital to shareholders without the assistance of capital markets.
Source: Simply Safe Dividends
AFL’s balance sheet also looks to be in decent shape. The company’s long-term debt to capital ratio is a modest 0.23, and the company generated more free cash flow ($6.6 billion) last fiscal year than its total book debt balance ($5 billion). Moody’s (Aa3) and S&P (AA-) have also assigned strong credit ratings to AFL.
Finally, it’s worth mentioning that AFL’s annual policy premiums have more than covered 100% of the company’s total claims for at least the last 10 years, highlighting the conservative approach AFL takes to managing its business. While insurance companies carry murkier liabilities than average firms, this data point gives us greater comfort in AFL’s operations.
Altogether, AFL’s dividend looks very safe to us.
Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
AFL’s dividend Growth Score was a strong 78, which means that the company has significant flexibility to grow its dividend going forward. While the business faces near-term exchange rate headwinds and operates in mature markets, the company’s low payout ratio (28%), consistent free cash flow generation, and healthy balance sheet support long-term dividend growth.
AFL has increased its dividend for 33 consecutive years and most recently raised its dividend by 5% in November 2015. The stock is one of 51 dividend aristocrats and appears to have plenty of flexibility to continue growing its dividend at a mid-single digit growth rate each year (management’s goal is to grow the dividend at a rate in line with the increase in operating earnings, excluding foreign currency impacts).
As seen below, AFL’s dividend has increased at a 5-6% annual rate in recent years.
Source: Simply Safe Dividends
Valuation
AFLAC Incorporated (NYSE:AFL) trades at 9.7x forward earnings and offers a dividend yield of 2.7%, which is above its five year average dividend yield of 2.4%. AFL’s dividend yield is likely too low for investors living off dividends in retirement, but its dividend growth is reliable and the stock’s total return potential is more interesting.
We believe AFL’s earnings can grow at least 3-6% per year over the longer-term, suggesting that the stock offers total annual return potential of 6-9% per year. The stock’s earnings multiple could also increase considerably and further boost total returns if Japan’s economy starts to improve and interest rates edge up. However, for the next year or so, these headwinds seem likely to persist.
Conclusion
Despite headwinds in Japan, AFL seems likely to remain a blue chip dividend stock for years to come. The company has strong brand recognition, benefits from economies of scale (low cost provider), and is very healthy financially. Today’s valuation appears to be undemanding, although it is impossible to predict when macro conditions in Japan will stabilize and begin showing signs of improvement. Until then, we expect AFL to continue improving the risk profile of its investments and work on numerous growth initiatives to position its business well for the long term. For long-term dividend growth and consistency, AFL looks like a reasonable bet to us.
Disclosure: None
