We downgrade Max Financial services to Neutral from Buy (stock is up 40% since Feb-2016 lows). IRDA’s relaxation of expense regulations, continuation of Axis Bank tie-up, and most importantly a strong FY16 performance has led to the recent outperformance. While we continue to believe that banca players will be long term winners in the insurance space, recent outperformance has led to valuations getting to +2.5x EV. With 16-17% ROEV and +15% growth expectation, we believe current valuations are at the higher end of the fair zone and hence we downgrade to Neutral. Transfer of stake to Axis and tighter regulations for non ULIPs, remain longer term risks.
Lower risks + strong FY16 led to the recent outperformance
Near term risks have dissipated: IRDA’s final guidelines on expenses are significantly more relaxed than the draft norms and there will not be any over-run in PAR book for Max with the new guidelines. This has been reflected in the recent outperformance as well.
FY16 performance was strong: Q4FY16 volumes picked up after finalisation of the agreement with Axis Bank. More importantly, Max has been able to almost eliminate cost over-runs leading to 18% post over-run margins which is best in class with HDFC Life. Some of the last 15 days’ outperformance reflects the strong FY16 showing.
Downgrade to Neutral ; Pricing in 20% NBP margins + 16-17% growth
We revise up our price target to R425/share from R370/share due to Mar-18 rollover and lower regulatory risks. Our target price implies an appraisal value of R175 bn with R72 bn of EV and R98 bn of PV of future business.
The current stock price implies more than 20% NBP margin and +17% growth. We do not see room for multiple expansion and hence downgrade the stock to Neutral.
Lower regulatory risks + Strong FY16 showing led to the outperformance
Max Financial Services has outperformed Bankex by 15-20% since our Feb-16 upgrade. We believe (i) Relaxation in expense regulations by IRDA in May 2016, (ii) Good performance in FY16 especially on opex and (iii) Continued Axis Bank tie-up has led to the outperformance.
Near term regulatory risks have dissipated: IRDA’s final guidelines on expenses are significantly more relaxed than the draft norms (Dec-15) and there will not be any over-run in PAR book for Max Life with the new guidelines. IRDA had issued draft expense guidelines for expense management in Dec-15 which could have led to R1.0-1.5 bn of over-run for Max Life on its PAR book. We think that due to industry lobbying,
IRDA has relaxed expense guidelines significantly leading to no over-run for Max Life.
FY16 performance was strong: Max Life’s Q4FY16 volumes picked up after a weak 9MFY16 performance due to the finalisation of the agreement with Axis Bank. More importantly, Max Life has been able to almost eliminate cost over-runs leading to 18% post over-run margins which is best in class with HDFC Life. With cost optimisation, Max Life’s cost ratios now are at par with the best in class banca players and that coupled with best in class persistency has led to almost elimination of over-runs.
Structurally will continue to gain from being a strong banca player: In our initiation report, we highlighted that banca players will continue to gain given their distribution edge and that was the case in FY16 as well. Max Life stacked up next to HDFC Life in our benchmarking and structurally remains well placed to gain among private insurers.
Positives mostly factored in; Downgrade to Neutral
While we continue to believe that banca players will be long term winners in the insurance space, recent outperformance has led to valuations getting to +2.5x EV. With 16-17% ROEV and 15% growth expectation, we believe the current valuation is at the higher end of the fair zone. We thus downgrade the stock to Neutral.
Our appraisal value of R175 bn uses aggressive assumptions:
We assume Max Life delivers premium CAGR of 17% over the last six years v/s industry growth of 14-15%.
Max Life delivered a NBP margin of 18.3% pre over-run and 17.8% post over-run. We factor in its margins improving from 17.8% post over-run to 20% over the next three to five years. Along with HDFC Life, this is the only other insurance company where we factor in an elimination of cost-overruns.
Previously we factored in risks from regulatory changes on PAR portfolio; we have removed the discount from regulatory risks as IRDA has relaxed expense norms. While this is a near term relief, longer term we continue to believe that regulations on surrenders and expenses need to be tightened on traditional policies.
Our valuation is Mar-18 based and hence factors in upside expected over the next nine months as well.
Our valuations factor in Max Life’s stake at 65%. Max Financial Services has in the past had to transfer 3-4% equity stake to Axis Bank at lower prices to retain it as a marketing partner. While we value Max Life as a full banca player, we believe Max Life will have to continue to transfer value to Axis Bank and hence value Max Financial Services stake in Max Life at 65% v/s 68% currently.