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  1. ICICI Lombard rated buy by Bank of America Merrill Lynch

ICICI Lombard rated buy by Bank of America Merrill Lynch

Premium valuations may be sustained as investment yields and return ratios are superior to peers; initiated with ‘Buy’ and TP of Rs 810

Updated: January 20, 2018 2:19 AM
ICICI Lombard, Bank of America Merrill Lynch, MISP, NIFTY , Motor Vehicle bill, IRDAI, GDPI, GDPI market share Lombard is the first Indian non-life insurance company to be listed. As a result, suitable comparable peer valuation metrics are not available. (Reuters)

We initiate coverage on ICICI Lombard (I-Lom) with a Buy rating as we believe (i) the company’s current stock price levels do not fully build in the industry growth potential on account of under penetration, (ii) Indian motor vehicle bill (pending with India’s Upper House) may act as a significant catalyst for the motor insurance segment (57% of Net Earned Premiums), (iii) company’s premium valuations may sustain as I-Lom’s investment yields and return ratios are far superior to global/regional peers. Our PO of `810 is derived using a residual income model and represents 20% upside from current levels.

Strong fundamentals aid sustainable advantage

The competitive strengths (as of FY17) that contribute to I-Lom’s success and positions it well for growth are (i) a combined ratio of 104.1% vs private sector average of 110%, (ii) a strong capital position with a solvency ratio of 2.10 vs IRDAI prescription of 1.50 and private sector average of 1.96, (iii) a deep-penetrating distribution network that has access to 618 of 716 districts in India and tie-ups with major auto OEMs, (iv) leveraging of technology throughout the policy lifecycle using data analytics, mobile apps, chatbots, telematics: 87.5% of policies initiated on digital platform, (v) robust risk management: share of losses from catastrophic events since FY13 is at 1.5-6.4%, despite GDPI market share in excess of 8%, and (vi) higher investment returns: 30.8% annualised total return on I-Lom’s equity portfolio since FY04, vs 17.5% on the benchmark S&P NIFTY index.

Upside and downside risks exist to earnings, valuations

Regulatory changes such as new MISP guidelines and the Motor Vehicle (Amendment) bill, pose significant upside risks to profitability of Motor Insurance segment, particularly the Third Party (TP) insurance which accounts for bulk of losses. Our estimates suggest that improvement in profitability in Third Party Motor Insurance may positively impact EPS forecasts by 30-45%. Downside risks to our forecasts/valuations largely emanate from market risks to investment income (>130% of pre-tax operating profits) because as per our estimates, 25bps drop in investment yield might impact EPS by 3.3-3.5%.

Conservative financials also support premium valuations

Lombard is the first Indian non-life insurance company to be listed. As a result, suitable comparable peer valuation metrics are not available. In comparison to global non-life insurance companies, we believe I-Lom deserves superior valuations as (i) insurance premium growth is much higher (15-20% vs 0-10% in developed markets) and is likely to remain higher over the medium term due to significant under penetration, (ii) the reported financial metrics for Indian non-life insurers are far more conservative in comparison to global peers as they are not allowed to discount their reserves and are also not allowed to book MTM gains in net worth.

Strong fundamentals have aided competitive advantage

The competitive strengths that contribute to I-Lom’s success and position it well for growth are: (i) a combined ratio of 104.1% vs private sector average of 110%; (ii) a strong capital position with solvency ratio of 2.10 vs IRDAI prescription of 1.50 and private sector average of 1.96, (iii) a deep-penetrating distribution network , (iv) leveraging of technology throughout the policy lifecycle; (v) robust risk management: share of losses from catastrophic events since FY13 is at 1.5-6.4%; (vi) higher investment returns: 30.8% annualised total return on I-Lom’s equity portfolio since FY04.

MISP guidelines, new Motor Vehicle bill to act as catalysts

Two major regulatory changes in motor insurance pose upside risks to the profitability of the motor insurance segment, which are currently not built into our forecasts: (i) MISP (Motor Insurance Service Provider) guidelines by which, the motor vehicle dealers who promote motor insurance products would be brought under IRDAI regulations thus increasing transparency, (ii) the New Motor Vehicle (Amendment) Act, which is expected to improve the profitability of the segment and also aid a higher proportion of renewals, thus enabling accrual of stronger growth.

Upside and downside risks exist to earnings, valuations

I-Lom’s profitability and financial prospects are subject to a variety of risks surrounding the non-life insurance industry in general and the company in particular: (i) concentration risks such as 42.3% of GDPI from motor insurance (in FY17) and 8.1% of GDPI from a single broker of an auto manufacturer; (ii) regulatory risks; (iii) catastrophic events; (iv) market risk to investments especially if the yield on investments change; and (v) risks due to insufficient reserves that can cause high volatility in earnings. At the same time, the regulatory changes highlighted above pose upside risks to our forecasts and valuations.

—Bank of America Merrill Lynch

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