Aflac provides supplemental health and life insurance products to customers in Japan and the United States.
- The Appreciation Fund initiated a position in AFL in 1Q09 at $24.88. (Disclosure: We have held AFL in the Appreciation Fund before, and another domestic mutual fund has held it in the past as well).
- Took advantage of weakness to add to our position in 2Q11 and 3Q11 following disappointing guidance
- Solid quarterly results in 1Q17 and 2Q17 drive stock appreciation in 2017
Headquartered in Columbus, Georgia, Aflac Incorporated (AFL) is a unique example of a differentiated insurance company. Aflac provides supplemental health and life insurance products to customers in Japan and the United States. Its insurance products are aimed at covering medical and nonmedical expenses that arise from medical emergencies. These expenses are typically not covered by either the national health insurance system in Japan, or primary insurance coverage in the United States, such as wage loss. In 2000, Aflac introduced the Aflac Duck, launching one of the most effective marketing campaigns, and catapulting the brand into a household name both domestically and abroad. Aflac was founded in 1955 by three brothers, and in 1974, the company began selling supplemental insurance in Japan. Today, Aflac Japan is the largest contributor to the topline, accounting for 71% of total revenues in 2016.
Aflac is the number one insurance provider in Japan in terms of policies in force, insuring one in four households. In fact, Aflac is the market leader in cancer and medical insurance in Japan, with 63.7% and 16.7% market share, respectively. Cancer and medical insurance are classified as third sector insurance products. As compared to the commoditized first sector insurance products, such as life insurance, third sector products are associated with higher returns. We believe Aflac’s focus on third sector products has been an important contributor to the company’s ability to sustain above-average returns. Competitors noticed, as many have entered the third sector to compete directly with Aflac over the last decade; despite the flurry of competition, Aflac has been able to maintain its leading position in a growing market through product innovation and partnership with distributors like Japan Post. In fact, Aflac is currently marketing a new third sector product in Japan, income-support for customers in their 20s through 40s.
In both Japan and the United States, healthcare costs are increasing rapidly due to a variety of factors, including an aging population. With rising out-of-pocket healthcare expenses, we believe supplemental insurance policies will become even more essential in both countries. Known for a quick turnaround on claims and customer loyalty, Aflac is well-positioned to service this growing need. We believe these trends will help Aflac Japan grow its third sector sales at a 4%-6% compound annual growth rate (CAGR), and Aflac US grow its sales at a 3%-5% CAGR, in-line with management’s long-term guidance.
A Long-Term View
Negative interest rates in Japan and artificially low interest rates in the United States have pressured investment returns for Aflac over the past few years. Despite the headwinds, Aflac continues to execute and grow its core business. Investors are noticing, as is evidenced by its 17% year-to-date return. Long-term, we believe Aflac will persist as a uniquely differentiated insurance company with above average returns and consistent, steady growth.
As of September 30, 2017, shares traded at $81.39, a 6% discount to our steadily growing private market value of $86.86.
U.S. Silica is one of the largest producers of silica in North America.
- We initiated our position at $22.77 during the third quarter of 2013. We believed in the strengths of the company’s competitive advantages and its attractive cash flow. (NOTE: we hold SLCA in several domestic strategies.)
- We have seen a significant increase in oil and natural gas production in North America which has resulted in a need for a product to help support the walls of the well to allow the oil and gas to flow to the surface. Therefore, there has been a substantial increase in the demand of silica because it meets the requirements and is abundant and low in price.
- U.S. Silica’s balance sheet remains in an excess cash position which has allowed the company to take advantage of opportunities during downturns and take market share from its balance sheet constrained peers.
U.S. Silica is one of the largest producers of silica in North America. Silica, naturally occurring in sand, flint and agate, is used in the manufacture of glass, ceramics, and abrasives. The company was founded more than 100 years ago, and throughout time has built up substantial distribution capabilities. Their current distribution capabilities of silica mines and transload facilities around the country provide a low-cost advantage for the company. U.S. Silica’s customers span across various industries including oil and gas, glass, chemicals, foundry, building products, fillers and extenders, recreation, industrial filtration and treatment, and testing and analysis. The company’s industrial customers have been built up over decades, while the importance of the oil and gas customer base has ratcheted up more recently.
Significant Demand Increase
There has been a significant increase in oil and natural gas production in North America, primarily due to the technology improvements in drilling and fracturing well bores to increase production. Utilizing advanced approaches to drilling results in the need for a product to help support the walls of the well to allow the oil and gas to flow to the surface. Silica meets the requirements and is both plentiful in availability and low in price. Thus, there has been a substantial increase in the demand for silica as the length of wells increase combined with the benefits drillers are seeing in using higher volumes of silica. Demand for silica in the oil and gas industry is estimated to be up over 75 percent this year, which should outpace supply and support price stability.
Underappreciated Industrial Business
The tremendous growth of the oil and gas business has resulted in U.S. Silica’s longest standing business being overlooked by investors. However, the industrial business represents over 28 percent of the company’s operating profit and has exhibited slower, but more consistent growth through the years. Fueled by the growth in demand in the automotive and housing products end markets, the company has continued to invest capital in developing its presence. That capital investment has helped in the innovation of its product offerings to better protect the company’s competitive advantage for years to come.
Solid Balance Sheet
U.S. Silica’s management team has remained disciplined in its capital allocation through the years, even with the tremendous growth opportunities available to the business. Silica has consistently maintained an excess cash position and utilized periods of strong stock price appreciation to raise additional capital. A strong balance sheet has allowed the company to take advantage of opportunities during downturns in the industry, which its levered competitors can’t access. Today, U.S. Silica’s balance sheet remains in an excess cash position, giving it ample dry powder to continue to strengthen its competitive advantage and take market share from its balance sheet constrained peers.
The market continues to focus on the oil and gas segment and primarily the supply and demand mix of one region of the country. This creates an interesting investment opportunity for us as we appreciate the company’s logistic capabilities and strength in the industrial business to support any volatility in the oil and gas segment.
As of September 30, 2017, shares traded at $31.07, a 48% discount to our steadily growing private market value of $60.04.
Investing in small cap and mid cap stocks is more risky and more volatile than investing in large cap stocks. The intrinsic value of the stocks in which the Funds invest may never be recognized by the broader market.
On this page, we candidly discuss two individual companies to illustrate our investment process. These companies are current holdings of certain Funds, one of which was a top performer for the quarter and the other was, in our view, undervalued by the market. The information and our opinions were current as of September 30, 2017, but are subject to change. The information shown does not provide information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to purchase or sell any particular security. These securities do not represent all securities purchased, sold, or recommended to investors during the period. Past performance does not guarantee future results. The performance of any single portfolio holding is no indication of the performance of other portfolio holdings of any Fund or of any particular Fund itself. Portfolio holdings are subject to change. Click here for the top holdings of the Funds.