We came away from our recent meeting with LPI feeling positive on the group's prudent underwriting strategy and efforts to overcome the growing industry headwinds. However, as we are less bullish on its earnings pace, we are revising lower our net profit forecasts by 3.3% and 8.4% for FY12 and FY13 respectively. We downgrade our call to NEUTRAL, with our FV tweaked lower to RM14.82. Based on the current price and our dividend payout forecast, LPI’s dividend yield is still an appealing 5%.
Weaning off reliance on motor segment. The high-risk nature of the motor segment is not expected to significantly concern LPI as: i) LPI's motor contribution has been declining, dipping from 30% in FY10 to 24% in 9MFY12, and may fall further to 20%, ii)
the company has recognized its share of MMIP’s losses on a 'smoothed' basis, and iii) it adopts consistent strict underwriting policies.
Weaning off reliance on motor segment. The high-risk nature of the motor segment is not expected to significantly concern LPI as: i) LPI's motor contribution has been declining, dipping from 30% in FY10 to 24% in 9MFY12, and may fall further to 20%, ii)
the company has recognized its share of MMIP’s losses on a 'smoothed' basis, and iii) it adopts consistent strict underwriting policies.
High reinsurance not a concern. We are not overly concerned on the high usage of reinsurance, due to the following: i) LPI has minimal exposure to foreign exchange risks, ii) it conducts business with foreign reinsurers with at least an A- rating, and reviews the reinsurers’ performance annually, and iii) leading global reinsurers have been developing more sophisticated and resilient risk and capital management products. We think LPI's reinsurance programme is adequately prepared against counterparty risk.
The challenges ahead. LPI is focused on enhancing services, claims management and cost efficiencies moving towards 2016 when detariffication is expected to commence, while securing customer loyalty and agent productivity versus the rise in foreign insurance players. The management has expressed interest in venturing into the takaful industry, but given the licensing restrictions, it is adopting a wait-and-see approach for potential opportunities.
Downgrade to NEUTRAL, FV revised to RM14.82. We are revising downward our net profit forecasts by 3.3% and 8.4% for FY12 and FY13 respectively, due to: i) lower forecasts for earned premiums growth to 11.5% and 13% for 2012 and 2013 respectively, ii) a lower retention rate that is closer to ~60% and iii) a net commission ratio of 7.4% and 7.5% for 2012 and 2013 respectively. Our revised FV is now based on a three-year PE band of 19x against FY13f EPS, which implies a 14% premium to the weighted average PBV multiple of the industry’s recent M&A transactions.
Dividend yield still attractive. Although we are nudging down our dividend payout estimate to 95%, the dividend yield is still an attractive 5% at the current share price.
MOTOR
Motor segment ratio over premiums on the decline. We believe that the high-risk, lumpy nature of the motor segment is not expected to be of significant concern to LPI, due to the following: i) LPI's already-low reliance on motor premiums has been on a downtrend from 30% in FY10 to 24% in 1H12, while the management hopes to decrease its reliance further to 20%, ii) the share of MMIP losses has been recognized on a staggered basis, and iii) LPI's consistent strict underwriting policies will largely help to mitigate the upside in its claims ratio. The company generally does not offer third-party insurance coverage, opting to focus more on comprehensive coverage. Other considerations are minimising coverage to vehicle brands prone to theft and commercial-type vehicles.
Motor segment ratio over premiums on the decline. We believe that the high-risk, lumpy nature of the motor segment is not expected to be of significant concern to LPI, due to the following: i) LPI's already-low reliance on motor premiums has been on a downtrend from 30% in FY10 to 24% in 1H12, while the management hopes to decrease its reliance further to 20%, ii) the share of MMIP losses has been recognized on a staggered basis, and iii) LPI's consistent strict underwriting policies will largely help to mitigate the upside in its claims ratio. The company generally does not offer third-party insurance coverage, opting to focus more on comprehensive coverage. Other considerations are minimising coverage to vehicle brands prone to theft and commercial-type vehicles.
Staggering the absorption of share of MMIP losses. Our previous report stated that the motor segment's claims ratio in 4QFY11 spiked to as high as 99% due to a one-off occurrence in its share of Malaysian Motor Insurance Pool (MMIP) losses amounting to RM11.1m. The management said that for FY12, the share of MMIP losses borne by LPI has been staggered or 'smoothed' at RM2.6m-RM3m per quarter. We believe this could be recorded at slightly >RM3m for 4Q’s results but should not be a significant impact on the motor claims ratio so long as stringent underwriting is in place.
FIRE
Fire insurance premiums still the prime driver. Sales of fire insurance is expected to continue riding on the property loans growth, especially those offered by Public Bank, being the largest segment with superior underwriting margins before management expenses of >70%. According to the management, the gross premiums split is about half for residential properties and the remainder for commercial and industrial buildings, of which commercial properties have a slightly higher allocation. Commercial properties are deemed the best choice due to its higher premium values with moderate risk exposures. However, as we are less bullish on the property sector moving forward, we believe growth for this segment should moderate from FY13 onwards (9MFY12: 16% y-o-y growth).
FIRE
Fire insurance premiums still the prime driver. Sales of fire insurance is expected to continue riding on the property loans growth, especially those offered by Public Bank, being the largest segment with superior underwriting margins before management expenses of >70%. According to the management, the gross premiums split is about half for residential properties and the remainder for commercial and industrial buildings, of which commercial properties have a slightly higher allocation. Commercial properties are deemed the best choice due to its higher premium values with moderate risk exposures. However, as we are less bullish on the property sector moving forward, we believe growth for this segment should moderate from FY13 onwards (9MFY12: 16% y-o-y growth).
REINSURANCE
High reliance on reinsurers. As a general insurer, the company has traditionally ceded substantial premiums to reinsurers, as evidenced by the low retention ratio of 65% vs the industry average of about 81%, based on BNM's statistics. Although it is a good thing to have as much reinsurance usage as possible to mitigate claims risks, the company’s reliance on many global reinsurers has exposed it to international insurance cycles. However, we are not overly concerned, since: i) LPI has a minimum exposure in foreign exchange risks in USD (the main currency denominator in the global reinsurance market), ii) it is comfortable conducting business with foreign reinsurers of at least an A- rating from agencies like Standard & Poor's; the financial stability and reinsurance track records of these reinsurers are annually reviewed by the management and iii) leading global reinsurers have been revamping themselves with more sophisticated and resilient risk and capital management, after having experienced several tranches of major catastrophic losses for the past decade. We think LPI's reinsurance programme is adequate against counterparty risks.
INVESTMENT
Good mix of long-term investments and liquidity position. LPI's investment objective is to strike a balance between long-term capital growth and ample liquidity in its portfolio. It has a "buy and hold" strategy where the company focuses on investing in blue-chip securities with high dividend incomes, which are currently at >50% of its total investment portfolio. A large portion is invested into Public Bank's shares, mainly enlarged due to revaluations in its carrying value. Short-term cash investments comprise approximately 25% of its portfolio, while the remainder is largely allocated to government bonds and other held-for-maturity financial assets. The management is looking at a 4%-5% in overall investment yields.
KEY CHALLENGES
Preparing for detariffication. Recognising this challenge, LPI focuses on enhancing customer services with existing and prospective clients, as well as claims management which are partly attributed to underwriting prudence. It does not rule out further enhancing cost efficiency, mainly done by compressing management expense ratios as it moves towards 2016 when detarifficaton is expected to commence. We note that its management expense ratio is at a healthy level of ~15% and the management is confident to maintain this ratio below 20%.
Rise of the foreign players. As part of the industry’s’ liberalization, there has been an increasing trend of major foreign insurers entering the market through M&As. These players are likely to command better capital and global expertise in the market, have key access to certain customer segments, and most importantly, may have more experience in managing detariffication, as it may have managed events that happened overseas. However, LPI believes that its undiminished track record, focus on agent productivity and long-standing relationships with its clients will give the company the upper hand to maintain growth moving forward. Currently, agents contribute a substantial ~45% of LPI total premiums.
Venturing into takaful. Given the increasing incentives and expectations of the takaful industry, the management has expressed interest in the takaful business. However, this is still subject to BNM's restrictions on takaful licensing. As of August, there were 12 takaful players licensed by BNM.
High reliance on reinsurers. As a general insurer, the company has traditionally ceded substantial premiums to reinsurers, as evidenced by the low retention ratio of 65% vs the industry average of about 81%, based on BNM's statistics. Although it is a good thing to have as much reinsurance usage as possible to mitigate claims risks, the company’s reliance on many global reinsurers has exposed it to international insurance cycles. However, we are not overly concerned, since: i) LPI has a minimum exposure in foreign exchange risks in USD (the main currency denominator in the global reinsurance market), ii) it is comfortable conducting business with foreign reinsurers of at least an A- rating from agencies like Standard & Poor's; the financial stability and reinsurance track records of these reinsurers are annually reviewed by the management and iii) leading global reinsurers have been revamping themselves with more sophisticated and resilient risk and capital management, after having experienced several tranches of major catastrophic losses for the past decade. We think LPI's reinsurance programme is adequate against counterparty risks.
INVESTMENT
Good mix of long-term investments and liquidity position. LPI's investment objective is to strike a balance between long-term capital growth and ample liquidity in its portfolio. It has a "buy and hold" strategy where the company focuses on investing in blue-chip securities with high dividend incomes, which are currently at >50% of its total investment portfolio. A large portion is invested into Public Bank's shares, mainly enlarged due to revaluations in its carrying value. Short-term cash investments comprise approximately 25% of its portfolio, while the remainder is largely allocated to government bonds and other held-for-maturity financial assets. The management is looking at a 4%-5% in overall investment yields.
KEY CHALLENGES
Preparing for detariffication. Recognising this challenge, LPI focuses on enhancing customer services with existing and prospective clients, as well as claims management which are partly attributed to underwriting prudence. It does not rule out further enhancing cost efficiency, mainly done by compressing management expense ratios as it moves towards 2016 when detarifficaton is expected to commence. We note that its management expense ratio is at a healthy level of ~15% and the management is confident to maintain this ratio below 20%.
Rise of the foreign players. As part of the industry’s’ liberalization, there has been an increasing trend of major foreign insurers entering the market through M&As. These players are likely to command better capital and global expertise in the market, have key access to certain customer segments, and most importantly, may have more experience in managing detariffication, as it may have managed events that happened overseas. However, LPI believes that its undiminished track record, focus on agent productivity and long-standing relationships with its clients will give the company the upper hand to maintain growth moving forward. Currently, agents contribute a substantial ~45% of LPI total premiums.
Venturing into takaful. Given the increasing incentives and expectations of the takaful industry, the management has expressed interest in the takaful business. However, this is still subject to BNM's restrictions on takaful licensing. As of August, there were 12 takaful players licensed by BNM.
VALUATIONS REVISION
Net profit revised lower. We are revising our net profit forecasts downwards by 3.3% and 8.4% for FY12 and FY13 respectively. The downward revision is mainly due to: i) the upside in LPI's investment income being fairly limited given the company's conservative investment portfolio; although the company has substantial exposure to equity classes, we do not see realization of a large portion of these unless dividend income is compressed, ii) lower forecasts for earned premiums growth to 11.5% and 13% for 2012 and 2013 respectively, iii) a lower retention rate closer to ~60%, iv) a higher net commission ratio of 7.4% and 7.5% for 2012 and 2013 respectively.
These are, however, offset slightly by upward revisions due to: i) a lower tax rate of 23% and ii) expectations of its claims ratios dipping marginally to below 50% from 2013 onwards in line with LPI’s efforts to enhance its underwriting policies and pricing strategy.
Downgrade to NEUTRAL, rolling over our forecast to FY13 with FV revised to RM14.82. We are rolling over our forecast to FY13 EPS, implying a FV of RM14.82, which gives a 9.8% upside from the current share price. Hence we downgrade our call to a NEUTRAL. At the current price, LPI is trading at 17.5x FY13 PE and 2.2x forward BV. Our revised FV is pegged to a 19.0x average three-year PE band, and translates into 2.45x forward BV.
Still at a premium. With our FV, the forward PBV multiple is at a 14% premium to recent M&A transactions in the industry, excluding the pending disposal of CIMB Aviva to bids from severallarge global insurers.
Net profit revised lower. We are revising our net profit forecasts downwards by 3.3% and 8.4% for FY12 and FY13 respectively. The downward revision is mainly due to: i) the upside in LPI's investment income being fairly limited given the company's conservative investment portfolio; although the company has substantial exposure to equity classes, we do not see realization of a large portion of these unless dividend income is compressed, ii) lower forecasts for earned premiums growth to 11.5% and 13% for 2012 and 2013 respectively, iii) a lower retention rate closer to ~60%, iv) a higher net commission ratio of 7.4% and 7.5% for 2012 and 2013 respectively.
These are, however, offset slightly by upward revisions due to: i) a lower tax rate of 23% and ii) expectations of its claims ratios dipping marginally to below 50% from 2013 onwards in line with LPI’s efforts to enhance its underwriting policies and pricing strategy.
Downgrade to NEUTRAL, rolling over our forecast to FY13 with FV revised to RM14.82. We are rolling over our forecast to FY13 EPS, implying a FV of RM14.82, which gives a 9.8% upside from the current share price. Hence we downgrade our call to a NEUTRAL. At the current price, LPI is trading at 17.5x FY13 PE and 2.2x forward BV. Our revised FV is pegged to a 19.0x average three-year PE band, and translates into 2.45x forward BV.
Still at a premium. With our FV, the forward PBV multiple is at a 14% premium to recent M&A transactions in the industry, excluding the pending disposal of CIMB Aviva to bids from severallarge global insurers.
However, dividend still attractive. Assuming our revised dividend payout of 95% (based on the historical 10-year dividend payout trend), the dividend yield based on the current share price is still >5% for both FY12 and FY13. Although LPI does not have an official dividend policy, management does not see any downside on this payout trend. The high payout ratio would not compromise LPI's internal capital adequacy levels which are already above the minimum 130% capital adequacy ratio (CAR) requirement by the regulators.
Source: OSK
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