Pacific & Orient - OUTPERFORM - 20 June 2012

Having undergone a massive change in its business direction over the last four years, Pacific & Orient Berhad (“P&O”) has since engineered a major turnaround in its fortune and profitability.  As a general insurer, P&O is now posting strong profits but is still trading at low valuations and is hence primed for a rerating in our view. We are initiating coverage on P&O with an OUTPERFORM call and a price target of RM1.30, which implies an upside of 41% from its current share price of RM0.92.  P&O is the No 1 insurer in the market for motorcycle business and its continuing quota share arrangement of 20% in this segment business with Hanover Re of Germany reflects sound confidence in P&O business model in our view.  

Huge profits from the group’s motorcycle premium operation. P&O benefits from the 2010’s surge in premium rates here. Motorcycle insurance is the most profitable auto segment with huge growth potential leverage on the country’s steady 5% growth in GDP annually for 2010-2015. There is also an earnings upside to its claim ratio as the government may restructure the current tariff & loading ceiling with an adjustment price mechanism.

The current and next two years would see the group’s earnings jumping up by a 3-year CAGR of 14% (FY11-FY14), driven by huge profits from the group’s motorcycle premium operation, which is benefitting from the 2010’s surge in premium rates.

Extremely cheap valuations.  P&O is trading at just 3.5x to its core FY13 earnings and at just 0.77x of its FY13 book value. There could be upside to our profit forecasts as Hanover RE could potentially return its excess profits to P&O starting from 2013 as part of its previous quota share arrangement.  P&O is starting to manage its capital.  The group’s strategy is to maintain a strong and robust capital position in supporting the overall group’s business growth and to deliver excess returns to shareholders.  

Potential M&A. The owner is contemplating a partial divestment of P&O Insurance, a 100% owned subsidiary of P&O, which could reap the proceeds that is well above the current P&O’s implied stock market valuation.

41% upside to our base case valuation of RM1.30. Our Target Price of RM1.30 values the group at an undemanding FY13 earnings PER of 5.0x, which is at the low end of the 5.0-15.0x 2012/13 PERs of Malaysian general insurers.

M&A valuation of RM2.40 (translating to 9.1x).  Although there is already substantial price upside to its  fundamental, the stock is worth even more on a M&As basis. On this basis, we value P&O in the range of 2.0-2.5x its FY13 BV, which is a similar valuation to recent transactions on similar M&A deals.

Source: Kenanga