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Will Weak Japan Business Hurt Aflac's (AFL) Q4 Earnings?

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Aflac Inc.’s (AFL - Free Report) fourth-quarter results, scheduled for Jan 31, are expected to benefit from increased revenues from its U.S. segment. This unit has been performing strongly as evident by increasing revenues since 2010 for the past many years, a trend that continued through the first nine months of 2017. We expect to see strong financial performance and continued strength in the profitability of Aflac U.S. led by the ongoing investment by the company in this business.

Also, we expect to see new sales increase to continue in the fourth quarter given a number of growth initiatives such as the adoption of Everwell for increased penetration, delivery of value-added services and increased client retention; product partnering to drive improved account values and employee access; and investment in administrative capabilities. The Zacks Consensus Estimate for revenues from this segment is $1.6 billion, which translates into year-over-year growth of 6.7%.

Aflac’s top line remains sufficiently exposed to a challenging operating environment, primarily in Japan. The persistent low interest rate environment has led the company to deemphasize sales of first-sector (life insurance) products in Japan. Premium growth continues to be pressured by first sector savings product, WAYS, and a portion of block reaching paid-up status.

The curtailment of sale of first sector products as well as weakening of yen led to a decline in revenues by 0.3% in 2016 which further fell by 5.7% in first nine months of 2017. The restriction on sale of first-sector products, which carry higher premiums, along with currency volatility is further expected to suppress top-line growth in the region in the quarter under consideration.  

Investment income in this segment has been pressured by lower reinvestment yields and higher hedge costs and the same is expected for the fourth quarter. The Zacks Consensus Estimate for revenues from this segment is pegged at $3.7 billion, which signifies a decline of 17.8% year over year.

The company is in the process of converting its Japan branch into a subsidiary. The conversion will enhance Aflac's business development flexibility. The company booked approximately $24 million in pretax costs associated with its Japan branch conversion in the first nine months of 2017.

The conversion remains on track and the company expects to incur conversion costs of $120 million to $130 million pretax through mid-2018. These costs will hurt the company’s margins in the coming quarters.

Aflac derives almost 70% of total revenues from Japan, which exposes it to significant foreign currency volatility. This might hurt its margins.

However, the company’s continued efforts to return capital to its shareholders via share buyback will cushion its bottom line.

Earnings Surprise History

The company boasts an attractive earnings surprise history, having surpassed the Zacks Consensus Estimate in three of trailing four quarters with an average beat of 3.55%.

Aflac Incorporated Price and EPS Surprise

Here is what our quantitative model predicts:

Our proven model does not conclusively show that Aflac is likely to beat on earnings this quarter. This is because a stock needs to have both a positive Earnings ESP and a favorable Zacks Rank #1, 2 or 3 for this to happen. But that is not the case here as you will see below.

Zacks ESP: Aflac has an Earning ESP of -0.49%. You can uncover the best stocks to buy or sell before they’re reported with our  Earnings ESP Filter.

Zacks Rank: Aflac carries a Zacks Rank #2 (Buy), which increases the predictive power of ESP. However, we need to have a positive ESP to be confident about an earnings surprise. The company’s negative ESP thus leaves the case inconclusive.

We caution against Sell-rated stocks (#4 or 5) going into the earnings announcement, especially when the company is seeing negative estimate revisions.

Stocks Worth Considering

Here are some companies worth considering as our model shows that these possess the right combination of elements to beat estimates this quarter:  

Amerisafe Inc. (AMSF - Free Report) will likely report fourth-quarter 2017 earnings results on Feb 28. The company has an Earnings ESP of +1.61% and carries a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.ere.

Unum Group (UNM - Free Report) has an Earnings ESP of +0.83% and a Zacks Rank of 2. The company is expected to report fourth-quarter earnings results on Jan 31.

Trupanion, Inc. (TRUP - Free Report) has an Earnings ESP of +100%. This Zacks #2 Ranked company is expected to report fourth-quarter earnings results on Feb 13.

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