EUR 850.00 For Business Accounts Only

Morningstar | No-Moat PICC Group 2018 Net Profit Fell, Life NBV Growth Recovered in 2H. See Updated Analyst Note from 25 Mar 2019

No-moat PICC Group’s 2018 results recorded a 20% decline in net profit to CNY 12.9 million, dragged by a 22% net profit decline in its core P&C insurance segment and weaker investment returns, which were partially offset by improved underwriting margin of life and health segments. Given operating performance of its auto insurance business came in weaker than our expectation in the second half of 2018, we reduced our fair value estimate to HKD 3.50 from HKD 4 per share to reflect our less optimistic assumptions for its near-term auto insurance growth and weaker underwriting profitability for auto and commercial property insurance lines. The results confirmed our long-term thesis that the group’s auto insurance business is facing rising pressure in terms of intensifying competition, increasing technology adoption by peers and ongoing pricing liberalization.

The ongoing transformation of its life insurance segment toward long-term protection focused provider compounded the difficulties of the group. Non-auto insurance segment achieved robust growth and decent underwriting margin over the past few years, while its sustainability remains to be seen given the heavy involvement in policy-driven business and low policy visibility in these fields. The shares are fairly valued. Our new DCF-based fair value estimate implies 1.2 times forward price/book for its P&C insurance business, versus an average of 1.5 times forward price/book for PICC P&C since the beginning of auto insurance pricing reform in 2015, reflecting our expectation for weakening market position over the long run. Our fair value estimate also implies zero valuation for its life and health insurance segments, to factor in its weaker-than-peer fundamentals for its life insurance business. P&C, life, and health insurance business contributed 76%, 20%, and 3% of total premium income, respectively, and 97%, 4%, and 0.1% of net profit in 2018.

Both life and health insurance saw improved business structure in 2018. Given tightening regulations, the company scaled back the sales of short-term insurance products, leading to a 33% decline in life insurance new premium to CNY 54.3 billion. The proportion of regular premium expanded to 60% of total premium, while regular premium sold by agent channel increased to 19% of total new premium versus 5.6% in 2015, this level remains low compared with listed peers at around 40%. New business value, or NBV, increased 0.8% as growth picked up to 49% in the second half versus a 22% decline in the first half on low base. NBV margin nearly doubled to 33% as product mix changed. Driven by large scale of its new business, embedded value of life insurance grew 14% from 2017.

Hampered by increasing competition, PICC P&C’s auto insurance growth slowed to 3.9% and market share slid 10 basis points to 33%. The business slid into losses in the second half, with combined ratio surging to 100.2% versus 96.5% in the year-ago period. This is the first underwriting loss over the past six years and was compounded by a 1% decline in auto insurance premium income and lifted selling expenses, as the third round of auto pricing liberation expanded into three new cities. Looking into 2019, PICC P&C’s auto insurance premium outpaced the industry average despite new auto sales remaining negative. Given weakening auto sales, we expect PICC P&C’s auto insurance will achieve premium growth at around 5%. By increasing sales contribution from lower-risk customer group including self-owned car drivers, and shifting distributor mix toward lower-cost direct sales platforms, we expect a relatively steady combined ratio, probably at the cost of modest market share loss.

Non-auto insurance business became the bright spot in fiscal 2018, with premium robustly increasing 32% and combined ratio improving by 0.7 percentage point to 98.5% in 2017, driven by strong growth in liability, accident and health, agriculture and credit guarantee insurance lines. Investment income dropped 22% and 7%, respectively, in the second half and the full year, as total investment return declined to 4.5% from 5.3%. With potentials for easing regulations on selling expense quotas and better pricing coordination among auto insurance leaders in 2019, we expect this should translate to a slight improvement in underwriting margin. This, coupled with modest recovery in investment return, leads to our expectation for a double-digit growth in net profits for 2019.