Wednesday, 13 March 2013

Pacific & Orient - Capital management the next catalyst

We are maintaining our rating on Pacific & Orient (“POB”) as an OUTPERFORM. Our target price has been raised to RM1.80 to factor in a higher shareholders fund after the recent disposal by it of a 49% interest in P&O Insurance (POI), giving it a new sustainable ROE of 12% and a potential total upside of 38% over the next 12 months. P&O has arguably the most profitable segment in the business, i.e. motorcycle insurance. Given that its claims provisioning has been likely overly provided, we expect an allowance write-back in FY13 and this should reduce doubts over its claim quality. Besides, management indicated that it would be comfortable with an internal core capital ratio of 170%. As such, there could be an upside risk to our dividend forecast, which would allow for a reduction in its internal core capital ratio to 170% from the estimated 200% by end-FY13 according to management. P&O’s valuations of 6.9x FY14 PER & 0.7x P/BV are undemanding together with a high 5.7% net dividend yield (assuming a 40% payout). We expect investors to increasingly favour P&O. We are raising our P&O’s TP to RM1.80 (from RM1.60 previously) based on 1.0x its FY14 BV.

Superior claim quality. P&O has arguable the most profitable segment in the business, i.e. motorcycle insurance. The claims in all its general insurance segments here for the business are lower than the industry levels. On the overall, P&O’s claim ratio of 44% compares favourably with the industry’s average of 75%. Given its prudence practices in claim provisioning, we expect the group likely to write back some of the allowances in this year, which should lead to a lower than expected claim ratio than our forecast of 50%. Having met management recently, we understand that the group’s claim ratio is still improving and likely to decline to 40%. We expect investors to increasingly favour P&O as they begin to have greater confidence in its claim quality.

Dividends could surprise on the upside. Post the 49%-stake disposal in POI, P&O has recently announced a special dividend of 15 sen/share. On top of this, we believe that the group has the capacity to further return more of its core capital to shareholders. Management indicated that it would be comfortable with a 170% Internal Core Capital Ratio (ICAR) to comply with BNM’s Risk-Based Capital Framework vs. the actual 173% ratio recorded as at 31 Dec 2012. The 170% ICAR is a comfortable level to match its premium growth rate of in the mid-single digit over the next few years. Our dividend forecast assumed a conservative payout ratio of 40%, but there could be an upside risk to our forecast should management fail to identify any investment targets and decide to return the excess capital to shareholders.

Meanwhile, the group is looking for proposals to improve the liquidity and marketability of POB shares. We think that another share split exercise is possible in this respect. Recall that in 2010, the group had split its shares at a ratio of 1:1 then. We would view a share split move positively if it happens. Capital management will be the next price catalyst for the stock in our view.

Earnings forecast and target price changes. We have marginally raised our net profit estimates by 6% mainly to factor in a likely lower claim ratio ahead. Our target price has been raised to RM1.80 (post-disposal) from RM1.60 (pre-disposal) as we roll forward our valuation year to FY14 and see a sustainable ROE for the group at 12%. P&O’s current valuations of a PER of 6.9x and a P/BV of 0.7x supported by its high dividend yield of 5.7%. The stock now offers a higher >38% total return (32% capital gain and 5.7% dividend yield). We are thus maintaining our OUTPERFORM rating for now.

Source: Kenanga

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