Research Sector Report Hong Kong China Valuation not attractive enough; Downgrade to Neutral Industry-wide Combined Ratio has increased since 2013. For example, PICC P&C s (02328) aggregate combined ratio has increased from 92.4% in 1H12 to 93.6% in 1H13. According to industry experts we interviewed, this was mainly due to intensified competition in the industry, higher material costs, and higher labor costs. Rating: Rating Change: Top Pick Neutral Downgraded No strong policy support from the 18 th Third Plenum. According to the 18 th Third Plenum and the CIRC, the industry policy will promote the development of catastrophe insurance and agriculture insurance. We think the former is not a stable source of profit, and the latter is underdeveloped implying some growth potential. P&C Insurance Market Share Downgraded to Neutral from Positive for China P&C insurance sector. Our rating for China P&C insurance sector is Neutral because: (1) As P&C insurance industry in general showed a cyclical pattern, the industry-wide combined ratio in China may still rise in near future; (2) Uncertainty with future Motor Vehicle insurance reform; (3) Valuation not attractive enough as most P&C counters have outperformed HSI and HSCEI over the most of 2H13. (Source: CIRC) PICC P&C (02328). PICC P&C (02328), the largest P&C insurance company in China with a market share of 34%, is trading at 1.9x 2013PB or 1.7x 2014PB. According to the global ROE-PB relationship for P&C insurance companies, we think PICC P&C s (02328) fair valuation should be approximately 2x PB. Therefore we do not think PICC P&C s (02328) current valuation is attractive enough. Our rating for PICC P&C (02328) is Hold with TP of HK$12.5 based on 2x 2014PB. Analyst Felix Luo SFC CE Number:AQF573 Tel: (852)37191048 FelixLuo@gfgroup.com.hk GF Securities (Hong Kong) Brokerage Limited ( GF Securities (HK) ) 29-30/F, Li Po Chun Chambers, 189 Des Voeux Road Central, H.K. Company Name Code Rating Price (HK$) 13EPS ( %) 14EPS ( %) 13 PER 14 PER PICC P&C 02328 Hold 10.74 (13.7) (2.8) 11.4 11.7 2.3 1.9 18.8 China Life 02628 Buy 22.90 161.5 5.9 17.6 16.6 2.3 2.1 12.5 Ping An 02318 Buy 67.65 44.7 22.1 14.4 11.9 2.6 2.2 16.6 CPIC 02601 Buy 28.90 108.9 11.1 19.0 17.1 2.1 1.9 10.7 NCI 01336 Buy 24.45 74.5 14.6 11.6 10.2 1.7 1.5 13.4 China Taiping 00966 Buy 14.52 34.4 37.2 19.8 14.5 1.8 1.5 8.5 12P/B 13P/B 13ROE (%) Source.. Company data, GF Securities (HK) Research
Review of China P&C insurance sector Industry-wide Combined Ratio increased since 2013. For example, PICC P&C s (02328) combined ratio has increased from 92.4% in 1H12 to 93.6% in 1H13; Ping An (02328) s combined ratio has increased from 93.1% in 1H12 to 95.5% in 1H13 (due to the seasonality of Combined Ratio, it is only fair to compare 1H12 with 1H13, or similarly compare 2012 with 2013). According to industry experts we interviewed, the increase was mainly due to intensified competition in the industry, higher material costs, and higher labor costs. Combined Ratio of major China P&C insurance players increased since 2013 Combined Ratio 1H10A 1H11A 1H12A 1H13A 2010A 2011A 2012A PICC P&C (02328.HK) 96.7% 92.5% 92.4% 93.6% 97.8% 94.0% 95.1% Ping An 96.5% 92.9% 93.1% 95.5% 93.2% 93.5% 95.3% China Pacific 94.5% 91.1% 94.2% 97.7% 93.7% 93.1% 95.8% China Taiping 99.9% 98.4% 98.0% 99.5% 101.0% 99.9% 99.8% Source: the Company, GF Securities (HK) Research Profitability on Motor Vehicle insurance decreased; diversification of P&C insurance premiums is needed. Take PICC P&C (02328) as example, its underwriting profit margin of Motor Vehicle insurance has decreased from 7.0% in 1H11, to 5.9% in 1H12 and to 2.6% in 1H13. This is mainly due to intensified competition and rising material costs. As a result, companies such as PICC P&C (02328) had to take diversification measures to maintain its profitability. One of the solutions is to develop agriculture insurance. For PICC P&C (02328), currently its agriculture insurance is only 15% of total turnover but the demand on agriculture insurance is still high. PICC P&C s (02328) example showed decreased profitability on Motor Vehicle insurance 1H10A 1H11A 1H12A 1H13A FY10A FY11A FY12A Loss Ratio (%) Motor vehicle insurance 67.4 67.8 62.9 64.5 68.2 68.7 66.4 Commercial property 52.3 55.9 50.2 46.3 66.0 55.3 63.9 Liability insurance 64.4 60.7 57.3 52.0 62.5 59.5 55.5 Accidental and health 67.3 64.1 57.7 67.6 63.4 63.2 62.5 Cargo insurance 50.5 40.0 34.2 33.6 48.8 39.3 36.7 Other insurance 68.6 46.9 64.0 45.9 68.3 53.7 64.4 Expense Ratio (%) Motor vehicle insurance 30.4 25.2 31.1 32.9 29.2 26.9 31.8 Commercial property 33.4 40.4 32.7 36.2 38.2 40.5 34.6 Liability insurance 33.9 36.7 34.5 35.7 35.9 33.6 36.5 Accidental and health 32.6 34.7 30.5 27.2 35.8 33.7 33.1 Cargo insurance 38.8 36.5 42.0 24.9 38.0 34.0 39.8 Other insurance 26.5 35.2 22.8 23.2 30.5 27.1 23.2 Underwriting Profit Margin (%) Motor vehicle insurance 2.2 7.0 5.9 2.6 2.6 4.4 3.8 Commercial property 14.3 3.6 17.1 17.5-4.2 4.2 1.5 Liability insurance 1.7 2.6 8.2 12.3 1.6 6.9 8.1 Accidental and health 0.1 1.2 11.8 5.2 0.8 3.1 4.4 Cargo insurance 10.7 23.5 23.8 41.5 13.2 26.7 23.5 Other insurance 4.9 17.9 13.2 30.9 1.2 19.2 12.4 Source: the Company, GF Securities (HK) Research No strong policy from the 18 th Third Plenum. China has released a series of policies for the insurance sector following the 18 th Third Plenum. A few policies are related to P&C insurance sector including: 1. The CIRC continues to promote development of catastrophe insurance. Page 2 of 5
2. The CIRC continues to promote development of agriculture insurance. Our comments: 1. Catastrophe insurance is not a stable source of profit. Take Year 2012 as an example, of the USD 186 billion in total damage caused by catastrophic events in the world (Source: Sigma), more than USD 77 billion were covered by insurance. This makes 2012 the third-most expensive year for the insurance industry (in 2011 record earthquakes and floods contributed to losses of over USD 126 billion; and in 2005 Hurricanes Katrina, Wilma, and Rita alone caused claims of over USD 100 billion). 2. Agriculture insurance is underdeveloped in China, implying growth potential. According to the CIRC, China s agriculture insurance premium was RMB30.7billion. This is equal to agriculture insurance penetration of 0.5%, and lower than the world average of 0.9% (Source: World Bank). The agriculture insurance is underdeveloped in China, implying growth potential for P&C insurance players. Agriculture insurance penetration is approximately 0.9% as world average Source: World Bank, GF Securities (HK) Research Outlook of China P&C insurance sector Downgraded to Neutral for China P&C insurance sector. Because: (1) As P&C insurance industry in-general showed a cyclical pattern, the industry-wide combined ratio in China may still rise in near future; (2) Uncertainty with Motor Vehicle insurance reform; (3) Valuation not attractive enough. Industry-wide combined ratio in China may still rise. The cyclical nature of the P&C insurance industry refers to the upward and downward movements in insurance prices and the combined ratio, which might takes 6 to 9 years. The typical explanation is that the P&C insurance industry causes the cycle more or less on its own, through periods of destructive competition followed by cutbacks in supply. The motor insurance underwriting cycle in US is approximately 5 years, and in the UK 5-7 years according to some statistics. The chart below shows the existence of European motor insurance underwriting cycle in the past decade as an example. As the China industry-wide combined ratio has just started to rise (since 2012 or 2013), we think it may still rise in near future. Page 3 of 5
Cyclical pattern of combined ratio of Motor Vehicle insurance in Europe Source: CEA Statistics N 38, GF Securities (HK) Research Note: the curve represents the average Combined Ratio of motor insurance of 21 European nations Uncertainty with proposed marketization of Motor Vehicle insurance. With the proposed future marketization of motor insurance rate by CIRC, it was generally worried that premium would fall and combined ratio would increase. Case Study: Shenzhen introduced a flexible commercial auto insurance rate in March 2011. Shenzhen's pilot project shows that (according to the actual operation results released by the Shenzhen Bureau of the Insurance Regulatory Commission): average premium fell by 4.64% after the flexible rate mechanism was adopted, but the combined payout ratio was stable and settlement of claims fell by 2.8% YoY. The fall in small-amount cases was particularly noticeable. In conclusion, the overall effects of Shenzhen motor insurance rate marketization were slightly negative. Valuation not attractive enough. According to the global ROE-PB relationship of P&C insurance players, there is an upward sloping relationship as shown by the chart below. Take PICC P&C (02328) as an example, it is the largest P&C insurance company in China with a market share of 34%. Our estimated ROE is 18.8% in 2013 and 15.4% in 2014 for PICC P&C (02328). According to the slope, its fair valuation should be less than 2x PB. Currently PICC P&C s (02328) closing price represents 1.9x 2013PB or 1.7x 2014PB. We do not think the current valuation is attractive enough. Our rating for PICC P&C (02328) is Hold with TP of HK$12.5 based on 2x 2014PB. Global ROE-PB relationship of major P&C insurance companies PICC P&C s (02328) fair valuation supposed to be about here, approx. 2x PB Source: AON Benfield, GF Securities (HK) Research Note: No Hit are companies which have avoided any quarter with a net income loss over the previous 24 quarters (excluding the financial crisis quarters Q3 and Q4 2008). +1 Hit are companies which failed to avoid that. Page 4 of 5
Company Rating Definition The Benchmark: Hong Kong Hang Seng Index Time Horizon: 12 months Rating Definition Buy Relative Performance >15%; or the fundamental outlook of the company or sector is favorable. Accumulate Relative Performance is 5% to 15%; or the fundamental outlook of the company or sector is favorable. Hold Relative Performance is -5% to 5%; or the fundamental outlook of the company or sector is neutral. Underperform Relative Performance <-5%; or the fundamental outlook of the company or sector is unfavorable. Sector Rating Definition The Benchmark: Hong Kong Hang Seng Index Time Horizon: 12 months Rating Definition Positive Sector outperforms the Hang Seng Index by 10% or more; or the fundamental outlook of the sector is positive. Neutral Sector outperforms or underperforms the Hang Seng Index by -10% to 10%; or the fundamental outlook of the sector is stable. 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GF Securities (Hong Kong) Brokerage Limited. All Rights Reserved. 29-30/F., Li Po Chun Chambers, 189 Des Voeux Road Central, Hong Kong Tel.: (852) 3719-1111 Fax: (852) 2907-6176 Website: www.gfgroup.com.hk Page 5 of 5