CHSI Catalyst Health Solutions, (MM)

Aflac Inc.’s (AFL) first-quarter 2012 operating earnings per share of $1.74 outpaced both the Zacks Consensus Estimate of $1.65 and the year-ago quarter’s earnings of $1.62. Operating earnings climbed 6.3% year over year to $814 million. A stronger yen/dollar exchange rate and higher investment income related to portfolio de-risking boosted the operating earnings per share by 4 cents and 5 cents, respectively.

Operating earnings in the reported quarter excluded after-tax negative impact of realized investment losses from securities transactions and impairments of $81 million or 17 cents per share compared with $357 million or 75 cents per share in the year-ago quarter. This was partially offset by the positive impact of derivative and hedging activities worth $52 million or 11 cents per share in the reported quarter, as opposed to the negative impact of $19 million or 4 cents per share recorded in the year-ago period.

Including one-time items, Aflac’s GAAP net income for the reported quarter surged over 100% to $785 million or $1.68 per share against $389 million or 83 cents per share in the year-ago period. Total acquisition and operating expenses spurted 6.8% year over year to $1.40 billion, while benefits and claims increased 13.2% year over year to about $3.65 billion.

Total revenue for the reported quarter spiked up 21.9% year over year to $6.24 billion, slivering past the Zacks Consensus Estimate of $6.2 billion. Despite the ongoing derisking activities, total revenue benefited from strengthening of yen against the dollar along with consistent improvement in the U.S. and better-than-expected performance in Japan. While Aflac Japan contributed 78% to the total revenue, Aflac U.S. contributed the remaining 22%.

Total revenue in Japan increased 12.0% year over year to $4.9 billion. Reflecting the stronger average yen, premium income from the Japanese operations in terms of dollars was up 12.0% year over year to $4.1 billion in the reported quarter.

Net investment income from the Japanese operations increased 12.5% year over year to $730 million, primarily spurred by a stronger yen/dollar exchange rate, which was 79.59, or 3.4% stronger than the average rate of 82.32 in the year-ago quarter. Consequently, pre-tax operating earnings in Japan climbed 6.8% year over year to $1.0 billion.

Besides, Aflac U.S. generated revenues of $1.4 billion, up 5.2% over the prior-year quarter. Net investment income from the U.S. operation saw an uptick of 5.5% year over year to $152 million. Premiums from the U.S. operations were up 5.2% year over year to $1.2 billion. Despite the lingering weakness in the U.S., total new annualized sales climbed 4.5% year over year to $351 million as the broker channel showed improvement and are taking up initiatives to reach out to the brokers of the large-case employer market, thereby outperforming for the fifth consecutive quarter.

Subsequently, pre-tax operating earnings in the U.S. climbed 8.1% year over year to $271 million, while persistency improved to 74.7% from 73.0% in the year-ago quarter.

Financial Update

As of March 31, 2012, total investment and cash were $103.1 billion compared with $103.46 billion at 2011-end, while shareholders' equity totaled $13.64 billion against $13.50 billion at the end of 2011. Shareholders' equity per share was $29.19 at the end of the reported quarter, up from $27.76 per share reported at the end of 2011.

At the end of the reported quarter, Aflac projected its risk-based capital ratio in the range of 500–540%, compared with 493% at 2011-end, while its solvency ratio in Japan also witnessed considerable improvement. During the reported quarter, net unrealized gain on investment securities and derivatives were $1.4 billion as compared with $1.2 billion at 2011-end.

Annualized return on average shareholders’ equity for the reported quarter was 23.6% against 16.6% in the prior quarter. On an operating basis (excluding realized investment losses and the impact of ASC 815 on net earnings, and unrealized investment gains/losses in shareholders' equity) Aflac’s return on average shareholders’ equity came in at 27.1%, up from 22.7% in the previous quarter.

On February 8, 2012, Aflac announced the pricing of long-term fixed rate notes worth $750 million in two tranches. Ratings agency A.M. Best assigned debt ratings of “a-” to the notes with a stable outlook. One set of 5-year senior notes are priced at par value of $400 million with a coupon rate of 2.65%. These notes are issued at a price of $99.911 that should generate yield of 2.669%.

The other tranche of 10-year fixed rate senior notes are priced at par value of $350 million with a coupon rate of 4.00%. These notes are issued at a price of $99.820 and are expected to yield 4.022%. Management plans to use the proceeds from the sale of these notes to repay Aflac’s 1.87% Samurai notes worth $347 million (26.6 billion yen) that is due in June 2012. Besides, the remaining amount of the proceeds is expected to inject ample liquidity by utilizing funds for general corporate and capital purposes.

Guidance

Concurrent with the release of first quarter’s result, Aflac revised its outlook for 2012. The company expects Aflac Japan to grow by about 10% in 2012, way higher than the prior band of -2% to 5%. The revenue projection for Aflac U.S. revenue is reiterated at 3–8%.

Besides, management also raised its earnings guidance for 2012 in the range of 3–6% over 2011 from the prior estimate of 2–5%, reflecting the impact of new accounting for deferred acquisition cost (DAC) by approximately 5 cents per share and portfolio derisking. Accordingly, the earnings growth stands within $6.46–6.65 per share for 2012. Aflac anticipates the earnings growth to improve further in 2013.

Dividend Update

Concurrently, the board of Aflac announced a regular cash dividend of 33 cents per share to be payable on June 1, 2012 to its shareholders of record as on May 16, 2012.

Earlier, on March 1, 2012, Aflac paid a dividend of 33 cents per share to its shareholders of record as on February 15, 2012. The company had hiked its dividend by 10% to 33 cents in October 2011.

Our Take

Over the years, Aflac has been significantly focusing on strengthening its insurance operations through successful product launches and the expansion of its distribution system, which has been significantly contributing to its strong sales results. This has also enabled the company to generate healthy capital ratios and cash position, while raising dividends from time to time. However, higher operating expenses continue to be a deterrent for desired advancement.

Although the near-term outlook remains cautious, given the effect of portfolio derisking activities and the continued low-interest-rate environment in Japan that is also reflected in the company’s guidance, we believe that a stable economy in the long term will gather momentum and negate interest and currency risk, thereby providing more profitable investment opportunities to Aflac. Going ahead, the company’s strong capital and surplus cash position is expected to mitigate balance sheet risks and provide liquidity cushion in the long run, as well as return value to shareholders consistently. Hence, we continue to retain our Neutral stance on the stock, with a Zacks Rank #4, implying a short-term Sell rating.

Meanwhile, Aflac’s peer Unum Group (UNM) is slated to release its results after the closing bell on May 1, 2012, while another peer Catalyst Health Solutions Inc. (CHSI) is yet to declare its earnings schedule for the first quarter of 2012.

 
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