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On May 7, we downgraded life and health insurer – Aflac Inc. (AFL - Analyst Report) to Underperform based on its faltering financial growth outlook.

Why the Downgrade?

Estimates for Aflac have witnessed a steady decline since its first-quarter 2013 results on Apr 24. The company’s first-quarter earnings per share of $1.69 comfortably surpassed the Zacks Consensus Estimate of $1.62, but lagged the year-ago quarter’s earnings of $1.74. Meanwhile, total revenue of $6.21 billion missed the Zacks Consensus Estimate of $6.27 billion but inched up 0.5% on a year-over-year basis.

Following a tempered growth outlook, the Zacks Consensus Estimate for 2013 has gone down 2.7% to $6.17 per share in the last 30 days. The Zacks Consensus Estimate for 2014 also slid 4.2% to $6.54 per share. With the Zacks Consensus Estimates for both 2013 and 2014 going down, the company now has a Zacks Rank #4 (Sell).

Cause for Concern

Aflac’s top line remains sufficiently exposed to a challenging operating environment, particularly in Japan. Sales from its banks channel, WAYS life policies and other third sector cancer and medical products (together contributing about 75% to Japan’s top line) decelerated in the first quarter of 2013.

Management’s expectation of third sector revenue growth in Japan in the band of nil to 5% in 2013 further validates the lackluster results ahead. Despite the re-pricing initiatives taken in Apr 2013, Aflac projects a 40–60% decline in the WAYS sales in the upcoming quarters, after over 124% growth in 2012. This will severely weigh on the financials of the company.

On the other hand, Aflac’s U.S. operations are yet to gain traction given the deteriorated new annualized sales on the back of intense competition, low demand and reduced client activity from larger businesses. Management projectsnew annualized sales in the U.S. to witness sluggish growth of nil to 5% in 2013, driven by difficult comps.

Moreover,the company’s investment portfolio comprises about 43% in Japanese government bonds, which is being adversely impacted by the historically low interest-rate environment.The past few quarters have witnessed significant weaknessin yen as well, indicating deterioration in the upcoming quarters. Increasing expenses, lower investment yield and low rate environment have further impelled management to peg its earnings growth guidance at low- to mid-single digit in 2013.

Other Financial Stocks That Warrant a Look

While we prefer to avoid Aflac until we see some improvement in its performance, Amerisafe Inc. (AMSF - Analyst Report), Employers Holdings Inc. (EIG - Snapshot Report) and Hilltop Holdings Inc. (HTH - Analyst Report) carrying a Zacks Rank #1 (Strong Buy) appear impressive.

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