Profitability curve to rise over years: Morgan Stanley

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New Delhi | Published: November 7, 2016 6:10:00 AM

Premium valuations are justified on account of strong operational metrics and other factors.

Despite industry-leading cost and persistency ratios, IPru’s margins have been weaker than peers. (Reuters)Despite industry-leading cost and persistency ratios, IPru’s margins have been weaker than peers. (Reuters)

A balanced distribution mix, rising protection mix, and improving persistency/costs will lead to multi-year improvement in profitability, even as higher focus on ULIP could keep growth volatile. This should drive a strong 40% VNB CAGR during F16-19, which justifies premium valuations.

Market leader with sharp improvement in key operational metrics

We have a positive view on Indian life insurers with strong distribution and good operational metrics.
ICICI Prudential Life Insurance (IPru) is one such strong franchise, helped by its well-balanced distribution mix (including a captive bank tie-up with ICICI Bank) and a sharp improvement in cost and persistency ratios in recent years.

We estimate a strong 17% premium CAGR in FY16-19…

IPru has a high focus on selling unit-linked insurance products (ULIP, 80% of its premiums, 35% industry share) in relatively high income segments. This would drive growth amid improving equity and debt market conditions. ULIPs, over the medium term, compete well with mutual funds because of expense loadings declining to levels even below what regulations allow.

…and a strong 6 ppt improvement in margins  to 14% by FY19

Despite industry leading persistency and cost ratios, IPru’s margins have been lower than peers. We expect the gap to narrow in FY17-19 because of a rising share of protection mix, improving persistency ratios, and higher economies of scale.

Premium valuations are justified

Our price target of R365 implies 2.9x December 2018 EV and 18% upside potential, driving our Overweight rating. While valuations are significantly higher than regional peers, we believe this is justified by IPru’s superior operational metrics and distribution tie-ups (allowing it to gain market share and improve profitability in still nascent Indian insurance market), fast growing protection premiums, low balance sheet risk and high capital. Key catalysts include strong growth in protection premiums and continued strong equity market performance. Key downside risks include: weak equity markets; more competition in the protection business; weaker persistency ratios; a potential tie-up by ICICI Bank with other insurers; and an increase in corporate income tax rates.

Why Overweight

We agree valuations are not cheap, but we expect IPru to continue to attract premium multiples because of its superior operational metrics, fast-growing protection premiums, low balance sheet risk and high capital. This drives our Overweight rating. Within our India financials industry coverage, the 18% upside potential our price target implies for IPru supports our Overweight rating.

Key Value Drivers: (i) New business premium growth (distribution franchise) and margins (protection mix), (ii) Opex ratio, (iii) Persistency ratio, (iv) Equity market conditions.

Potential Catalysts: (i) Strong equity market conditions driving high premium growth (ii) Continued high growth in protection premiums, (iii) Additional bancassurance tie-ups.

We believe IPru will continue to gain market share in new business premiums because of its strong distribution mix and focus on unit-linked insurance products (ULIP). We expect a multi-year improvement in profitability because of rising protection mix, improving persistency ratios, and greater cost efficiencies. These drive our strong 40% value of new business (VNB) CAGR estimate for F16-19. The valuation is not cheap at 2.7x P/EV and about 32x VNB on our F18 estimates, but we expect it to remain at premium levels with the above backdrop.

Why is IPru’s margin profile significantly lower than peers’? Why will it improve?

Despite industry-leading cost and persistency ratios, IPru’s margins have been weaker than peers. This is because iPru has a lower share of traditional products (i.e., lower expense availability), negligible share of non-par guaranteed savings products, and low share of protection premiums. We expect limited focus on the guaranteed savings segment to continue, but a sharp improvement in protection mix, higher persistency and greater cost efficiencies to drive an almost 6 ppt improvement in margins in FY16-19.

What kind of premium growth can IPru deliver over the next two to three years? We expect IPru’s premiums (annual premium equivalent [APE] basis) to increase at a strong CAGR of 17% in FY16-19. Apart from improving macro conditions and a stabilising regulatory environment, this will be driven by IPru’s good distribution franchise and its focus on ULIP in the relatively less penetrated higher income segment. ULIP have a strong customer proposition and offer better returns than do mutual funds over the medium term. Having said that, we believe IPru’s premium growth could be volatile because 83% of premiums are from ULIP, the performance of which depends on equity market conditions, and IPru’s premiums have a higher ticket size (about R88K in FY16) compared with those of large private life insurance peers

(R34-45K in FY16) – this is also driven by ULIP and could be affected negatively in a sustained equity market slowdown.

How does one value Ipru?

We use P/EV methodology to value the Indian life insurers in our coverage. Our price target of
R365 implies 2.9x December 2018 EV. This is based on our assumption of sustainable RoEV of 18% (we are building improvement to 17% for FY19 and expect further improvement to 18% because of high potential for improvement in protection premiums in the medium term, low balance sheet risk, and strong capital ratios), long-term growth of nearly 10% (similar to the implied growth at Indian private banks), and cost of equity (CoE) of 12.8%.

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