In this article, I wanted to make a quick but long-term and big picture comparison of the two North American insurers I run into most often from here in Asia: Aflac Inc (AFL) vs. Prudential Financial Inc (PRU). AFL’s Asia exposure is primarily in its Japan business, which is actually larger and faster growing than its US business (source: Aflac 2019 Annual Report). PRU, on the other hand, has a portfolio roughly 90% allocated to the U.S. (source: Prudential 2019 Annual Report), and my wealth management business mostly sees them as one of the few US life insurers that cover US citizens living in Asia. PRU should not be confused with similar-sounding Prudential Plc (PUK), which will not be covered in this article.
AFL vs PRU: Dividend History and Yield
Looking at the dividend histories of Aflac vs Prudential over the past 20 years, we see PRU’s dividend has grown significantly faster over the past 10 years, though AFL also has grown its dividend very steadily and never needed to cut its dividend. For most of the past decade, the AFL’s “tortoise” dividend traded at over double the valuation (less than half the yield) as PRU’s apparently more aggressive “hare” dividend growth. PRU’s 6.7% yield indicates the market is pricing in a far higher chance that PRU will need to cut its dividend again, while AFL’s 3% yield seems to imply AFL’s pricing is more in the “steady growth with low downside risk” range.
AFL vs. PRU: Earnings History
Next, if we look at how well AFL and PRU cover their dividends with earnings, we see AFL has maintained a far steadier history of EPS growth with no annual losses in the past 20 years, while PRU’s earnings have been far more volatile with several losing 12-month periods. I have not looked deeply enough into PRU’s financials to see if the latest TTM loss makes a dividend cut imminent, as we saw around 2009 and 2014, but PRU’s dividend definitely seems to be “lower quality” than AFL’s.
AFL vs. PRU: Profitability
As I say in many of my articles on financials, including my most recent one on the Canadian banks, I generally apply the rule of thumb that we should prefer to own financial businesses with return on asset rates consistently above 1%. In the below chart, we see PRU’s ROA has barely touched 1% a few times over the past 20 years, while AFL has reported ROA numbers consistently 1% or more higher than PRU’s, often well above 2%. By this simple measure, AFL has consistently been a much more profitable insurer than PRU all century so far. As a “stress test” of AFL’s ROA, I noted that at the depth of the market crash this past March, AFL seemed to have no problem raising $1 billion bond issue at 3.6%, and these 10-year notes’ yield have already traded down to below 1.6%. Although this bond issue seems like it will cost Aflac an extra $20 million/year (2% yield difference x $1 billion x 10 years), this note at least clearly shows the bond market’s confidence in AFL’s continued profitability.
After leverage, the spread between the return on equity rates of AFL over PRU looks relatively tighter, but AFL’s ROE on its book value has been consistently higher than PRU’s and consistently above 10%.
AFL vs. PRU: Valuation vs. Book
On valuation of financials or other balance sheet intensive balances, it often makes sense to start with Price / Book ratio and adjust for unwritten losses vs. the premium for a quality business above net assets. This next chart shows that the market has historically valued PRU at a discount to book value, probably due to expected cyclical losses, while AFL traded at a significant premium to book value from 2000 until early this year. As with the dividend yield, AFL’s valuation multiple is a little over double that of PRU’s, though given the measures of AFL’s financial quality, AFL looks like a historic bargain at a 20% discount to book value. In absolute terms, if AFL can maintain its ROE above 10% over the next 10 years, buying AFL at this discount implies an expected rate of return of over 12%/year, of which 3% would come from the current dividend yield. A similar expected return calculation on PRU would seem to be based on a far more aggressive estimate that PRU’s ROE could remain consistently above 5%.
A quick look at the long-term fundamentals of these top two North American insurers seems to clearly indicate Aflac is the far more consistently profitable of the two, and seems to deserve to trade at more than double the valuation multiple of Prudential. Based on the ROE vs. price/book “back of the envelope” calculation, it seems reasonable to expect that AFL can deliver a double digit rate of return over the next decade so long as it can maintain its steady historic profitability. By contrast, PRU is much cheaper in terms of dividend yield and price/book ratio, but seems to be cheap for reasons that might easily keep its future rates of return lower than AFL’s. In terms of the respective logos, I would illustrate this call by saying “own the duck (AFL), not the rock (PRU).”
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Disclosure: I am/we are long AFL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: We are covered by insurance policies written by Prudential Inc.