A sharp slowdown in the motor business and lower interest rates will put pressure on ICICI Lombard’s FY21E performance. A sluggish market will likely increase competitive pressures from private players even as PSUs may slow down. Growth in the health business will likely be the silver lining. Even as we expect near-term performance to remain relatively stable for insurance companies, ICICI Lombard trades significantly above its fair value, prompting us to look at long-term opportunities elsewhere in the BFSI sector. Retain ‘sell’ rating with fair value (FV) of Rs 875.

ICICI Lombard reported 7% growth in Q4FY20 PBT (Rs 370 crore), reflecting slowdown in business (gross premium down 8% year-on-year and net premium up 7% y-o-y), increase in combined ratio to 100% from 98% y-o-y (98.7% q-o-q) and impairment in equity investments (25% of preprovisioning PBT). Investment yield moved up to 8.5% from 7.2% q-o-q due to profit booking. Increase in commission ratio (7% from 3% q-o-q and y-o-y) was the key driver of higher combined ratio; according to the management, this was due to higher retention which led to lower inward commissions. As such, it would be challenging to dissect the break-up of the combined ratio.

We expect ICICI Lombard to deliver 6% decline in gross premium in FY21E on the back of a sharp slowdown in motor, muted business in most wholesale segments, moderate growth in fire segment and some tailwinds to the health business following Covid-19-related anxiety to improve coverage. Lower interest rates will likely lead to a fall in interest income as well, translating into 11% earnings growth for the year. ICICI Lombard may be better-placed than most PSU competition. Two reasons – effective use of technology – ability to close policies and approve claims without physical visits, and better capitalisation levels. Competition from Acko, Go Digit and other frontline private players will continue/intensify.

We are revising down our estimates by 8% to reflect lower business volumes and increase in combined ratio and lower investment yields; we expect about 20% medium-term RoE and 11% EPS growth in FY21E followed by 13-16% growth in FY22-23E. Even as we expect the insurance sector to fare better than rest of the financial services, the sharp price corrections in the sector versus super-rich valuation for ICICI Lombard prompt us to take near-term risk and medium-term investment calls on other stocks. We prefer ICICI Bank (‘buy’, 28% upside) and ICICI Prudential Life (buy, 16% upside) over ICICI Lombard (retain ‘sell’) with RGM-based FV of Rs 875).