China Insurance Longer-term Value Emerges 2 February 2012 Some improvement in 2012 for the industry after a challenging 2011 2011 a difficult operating environment for life insurers 2011 was a tough year for China s life insurers, mainly due to the three reasons below. 1. New bancassurance regulations dampened sales While bancassurance still accounts for more than 50% of China s total premium income, the new bancassurance regulations imposed by the China Banking Regulatory Commission (CBRC) in November 2010 had not only significantly affected bancassurance sales activities at bank branches but also made insurers compete more fiercely for banks sales channels by paying higher commission rates. 2. Less attractive returns on insurance products China s life insurers are still highly reliant on savings-oriented and investment-linked products. However, higher bank deposit rates had rendered the returns on savings-oriented insurance products less attractive, while the emergence of high-yield wealth management products offered by banks further cannibalized the demand for insurance. In addition, a weak A-share market affected sales of investment-linked products. All these not only affected new business sales but also significantly increased surrender rates. 3. Difficult agent recruitment Life insurers also had difficulties in recruiting new agents to replace exiting agents (due to an industry downtrend, a national wage rise and labor shortage, and also rising income of other competing professions), thus limiting growth in the agency channels. Bright spots in 2012 While the difficulties experienced by the industry in 2011 are expected to follow through into 2012, the outlook in 2012 is comparatively brighter. Firstly, as the impact from restricted bancassurance sales implemented in November 2010 has already been discounted in 2011, premium growth may improve in 2012 due to a lower prior-year comparison base. Secondly, cannibalization from banks wealth management products may ease, as banks now offer fewer wealth management products after the recent reserve requirement ratio (RRR) cut and as the China Banking Regulatory Commission (CBRC) is now monitoring more closely these wealth management products. Overall, we expect some improvement in the challenging operating environment in 2012, with life insurers continuing to strive for growth. Stronger growth and more stable outlook for P&C insurers For the first eleven months of 2011 (11M11), China s life premiums dropped 9.9% YoY, while property and casualty (P&C) premiums grew 18.2%. In China, more than 70% of P&C premiums are derived from auto insurance, the demand for which remains quite stable and is not profoundly affected by bancassurance regulations, interest rate movement and agent recruitment, thus we expect a more stable outlook for P&C insurers. We also expect P&C insurers to sustain underwriting profitability given their improving business infrastructure and internal control. Analyst: Michael Tam, CFA :(852) 2820 6322 :michael.tam@sctrade.com Important: please refer to our disclosures and disclaimers at the end of this report.
CHINA INSURANCE 2 FEBRUARY 2012 CHINA S P&C AND LIFE MONTHLY PREMIUMS GROWTH YoY 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% -10% -20% -30% Jan 2007 Jul 2007 Jan 2008 Jul 2008 Jan 2009 Jul 2009 Jan 2010 Jul 2010 Jan 2011 Jul 2011 Sources: CEIC, South China Research P&C Life The protection market allows insurers to differentiate, mitigate competition from banks and drive long-term growth Insurers to add more protection elements to their life policies In December 2011, the China Insurance Regulatory Commission (CIRC) issued a guideline that encourage insurers to increase protection coverage of life insurance policies and leverage product innovation to meet diversified consumer needs. At previously mentioned, China s life insurers are still highly reliant on sales of savings-oriented and investment-linked policies, and these policies are vulnerable to competition from banks own wealth management products and highly sensitive to investment markets. The protection market, however, can only be served by life insurers and is relatively immune from competition from banks, investment markets and economic cycles. Going forward, as life insurers add more protection elements to their life insurance policies, they can better differentiate themselves from banks and have a more viable business model to drive long-term growth. Long-term growth story remains intact Despite the challenging operating environment in the short run, the long-term growth potential of life insurance in China remains bright given China s low insurance density and penetration, rising income, aging population and lack of social welfare protection. Trough valuation provides good entry opportunity for long-term investors Value emerges despite a lack of catalysts The sector is currently trading at high-single-digit VNB (value of new business) multiples compared with the average VNB multiples of ~20x in 2009 and 2010. At the current valuation level, we believe most of the industry s negatives have been priced in. However, since any meaningful re-rating would hinge on fundamental improvements and growth recovery, major catalysts are scarce at present. Nevertheless, we underscore the fact that current market expectation on the sector is low, so any positive news or development can drive sector performance. For investors who take a longer-term view, the current trough valuation provides a good entry opportunity to gain exposure to an industry with sound long-term potentials. Important: please refer to our disclosures and disclaimers at the end of this report. -2-
CHINA INSURANCE 2 FEBRUARY 2012 PEER GROUP COMPARISON -------PE------- -------PB------- -------Yield------- ROA ROE Ticker Company Mkt cap Price 2010A 2011E 2012E 2010A 2011E 2012E 2010A 2011E 2012E 2011E 2011E TP UP HK$bn HK$ x x x x x x % % % % % HK$ % 2628 China Life 637.9 22.60 15.4 21.1 15.2 2.64 2.53 2.24 2.2 1.4 1.9 1.65 12.0 23.10 +2.2 2318 Ping An 411.0 60.95 21.5 19.1 14.5 2.92 2.91 2.48 1.1 0.9 1.2 1.40 16.2 75.16 +23.3 2601 CPIC 218.9 25.60 20.8 18.0 14.3 2.23 2.17 1.94 1.7 1.8 2.1 1.92 12.2 32.70 +27.7 2328 PICC 124.0 10.12 18.4 10.9 9.7 3.14 2.83 2.25 2.6 2.5 1.6 3.75 29.0 11.92 +17.8 1336 New China Life 106.8 28.95 12.6 20.7 17.6 N/A 2.29 2.02-0.3 0.8 0.80 14.3 38.23 +32.1 966 China Taiping 24.4 14.32 10.8 27.1 14.2 1.88 1.50 1.34-0.1 0.3 0.69 7.7 19.42 +35.6 Source: Bloomberg TP: Consensus target price UP: Upside Potential Top picks: China Pacific and Ping An We prefer companies with higher P&C exposure and strong capital positions. China Pacific, with P&C insurance accounting for ~40% of profit and being the best-capitalized insurer, falls into this category. We also like Ping An for its leading growth momentum in premiums and strong agency force. Risks: 1. Pricing reforms in auto insurance According to Chinese media reports, CIRC intends to introduce pricing reforms in auto insurance. If the auto premium rates become deregulated, rates would probably decline. 2. Investment markets A weaker-than-expected investment environment would pose downside risks to insurers solvency ratios and investment yields. 3. Market risks The equity beta of most insurers are higher than 1. As such, the sector is likely to be more volatile than the broad market. Important: please refer to our disclosures and disclaimers at the end of this report. -3-
PING AN (2318 HK) 2 FEBRUARY 2012 BUY Date: 2 February 2012 HSI: 20,333.37 Share Price: HK$60.95 12-Mth Target Price: HK$75.16 (Bloomberg consensus) Upside Potential: +23.3% China Insurance SHARE INFORMATION Ticker: 2318 HK Market cap Total HK$411.0bn Market cap H shares HK$190.8bn Issued H-shares 3.13bn 3-year EPS CAGR 20.8% PEG 0.92x Embedded value (EV) RMB25.39/share Price/EV 1.95x ROE 18.3% ROA 1.49% Avg daily turnover HK$926m Estimated free float 53.7% 12-mth high/low HK$87.90/37.35 Major shareholder HSBC 19.77% Exchange rate RMB1 = HK$1.230 SHARE PRICE CHART HK$ 90.0 80.0 70.0 60.0 50.0 40.0 30.0 m shares 150 100 Ping An HSI (rebased) 50 - Feb Apr Jun Aug Oct Dec Feb Sources: Bloomberg, South China Research 1mth 3mths 6mths 12mths Share price chg +19.0% +8.4% -20.5% -20.6% Relative to HSI +7.9% +3.2% -11.4% -8.3% Analyst : Michael Tam, CFA : (852) 2820 6322 : Michael.tam@sctrade.com Important: please refer to our disclosures and disclaimers at the end of this report PING AN (2318 HK) Strongest growth momentum among listed peers Premium growth highest among peers In 2011, Ping An s total life premiums as measured under the new accounting standards grew 28.4% YoY, higher than CPIC (2601 HK) (+6.0% YoY to RMB93.2bn) and China Life (2628 HK) (flat YoY at RMB318.3bn). For P&C insurance, Ping An s total premiums received in 2011 (+34.2% YoY to RMB83.33bn) also outperformed its peers such as PICC (2328 HK) (+12.6% YoY to RMB173.4bn) and CPIC (+19.5% YoY to RMB61.6bn). Such strong growth momentum of Ping An in both life and P&C premiums are expected to continue into 2012, leveraging on its strong agency force. Strong agency force Ping An s strong premium growth was attributed to its strong and productive agency force. In 1H11, agents contributed nearly 70% of its first-year premium in life insurance, compared with 20-25% for China Life, China Pacific and Taiping. Ping An s strength in agency force should also support its growth in agency channels going forward. Ping An has also been stepping up agency training to improve its agents productivity and prepare for selling more policies with better margins. Margin expansion can be expected Under the old accounting standards, Ping An s total life premiums received in 2011 grew 13.7% YoY to RMB180.78bn. Under the new accounting standards, which exclude investment-linked and universal life products, the growth rate was much higher (+28.4% YoY to RMB118.97bn), indicating that Ping An has become less reliant on investment-linked and universal life products. This, together with a higher proportion of business coming from the agency channel, should help to improve margins. Short-term fundraising needs subsided after announcement of A-share CB issuance In December 2011, Ping An announced its plans to issue RMB26bn in A-share convertible bonds (CB). The proceeds of the CB would primarily be used for replenishing capital for its banking operations, in our view. While the CB, if successfully issued, should alleviate Ping An s further fundraising needs in the near term, it would also bring about an EPS dilution of 8%. However, the positive news is that the A-share CB would not increase the supply of H-shares. Underperformance in 2011 priced in negatives Ping An s share price performance was the worst among HK-listed Chinese insurers in 2011. Such underperformance should have already priced in some key negatives such as credit cost concerns for its banking business, weaker capital base and potential fundraising needs due to its strong growth profile. Undemanding valuation Ping An is currently trading at a high-single-digit VNB (value of new business) multiple, compared with the average VNB multiple of ~20x in 2009 and 2010. According to Bloomberg, the consensus target price (from 23 market estimates) for Ping An is HK$75.16, implying an upside potential of 23.3%. COMPANY BACKGROUND: Ping An provides a variety of insurance service in China. The company writes property, casualty, and life insurance. Ping An also offers banking services and other financial services. EARNINGS DATA Year to 31 December 2010A 2011E 2012E 2013E Net profit RMBbn 17.31 19.94 26.25 31.17 Growth YoY% +24.7 +15.2 +31.6 +18.8 EPS RMB 2.30 2.59 3.41 4.05 Growth YoY% +21.7 +12.7 +31.6 +18.8 BVPS RMB 14.66 17.02 20.01 23.67 Growth YoY% +26.7 +16.1 +17.5 +18.3 DPS RMB 0.60 0.47 0.61 0.73 Growth YoY% +33.3-22.2 +31.5 +18.1 PE x 21.5 19.1 14.5 12.2 PB x 3.4 2.9 2.5 2.1 Yield % 1.2 0.9 1.2 1.5 Source: Bloomberg Note: All prices in this report are based on the 1 February 2012 close -4-
CHINA PACIFIC INSURANCE (2601 HK) 2 FEBRUARY 2012 BUY Date: 2 February 2012 HSI: 20,333.37 Share Price: HK$25.60 12-Mth Target Price: HK$32.70 (Bloomberg consensus) Upside Potential: +27.7% China Insurance SHARE INFORMATION Ticker: 2601 HK Market cap Total HK$218.9bn Market cap H shares HK$59.2bn Issued H-shares 2.31bn 3-year EPS CAGR 19.7% PEG 0.91x Embedded value (EV) RMB12.80/share Price/EV 1.63x ROE 12.2% ROA 1.92% Avg daily turnover HK$269m Estimated free float 75.9% 12-mth high/low HK$35.45/19.78 Major shareholder Fortune Investment 18.79% Exchange rate RMB1 = HK$1.230 SHARE PRICE CHART HK$ 36.0 34.0 32.0 30.0 28.0 26.0 24.0 22.0 20.0 18.0 m shares 400 200 - CPIC HSI (rebased) Feb Apr Jun Aug Oct Dec Feb Sources: Bloomberg, South China Research 1mth 3mths 6mths 12mths Share price chg +15.8% +9.4% -15.4% -16.9% Relative to HSI +5.0% +4.2% -5.7% -4.0% Analyst : Michael Tam, CFA : (852) 2820 6322 : Michael.tam@sctrade.com Important: please refer to our disclosures and disclaimers at the end of this report CHINA PACIFIC INSURANCE (2601 HK) Strong capital base provides room for growth Capital position highest among listed peers In December 2011, CPIC gained regulator s approval to issue 10-year sub-debt of up to RMB8bn. After the issuance, CPIC s solvency ratio at the group level would reach about 300%, significantly higher than other listed peers. Such a strong capital position would allow CPIC to grow its premium base without any constraint on capital, and CPIC is under the least pressure to raise equity capital at the current trough valuation. The more stable P&C business accounts for ~40% of profit P&C insurance, which has a more stable outlook, accounts for ~40% of CPIC s profit. With premium growth and new business value growth above peer averages in 2011, CPIC s better growth momentum is expected to continue into 2012. Agent productivity and product mix upgrade gains as growth drivers The number of CPIC s life insurance agents had remained largely flat at 280,000 throughout 2011, while the industry saw negative growth. Looking into 2012, we expect agent recruitment to remain difficult. The good news is that CPIC actually achieved double-digit growth in first-year premium in the agency channel. That implies a double-digit rise in agent productivity and product mix changes, which were achieved by enhanced agency recruitment and training system, as well as the offering of more long-term policies that focus on protection and products. In fact, policies with payment terms of more than 10 years accounted for over 40% of CPIC s first-year premium in 2011. Going forward, although volume growth in life insurance would remain challenging, agent productivity and product mix upgrade should drive growth in CPIC s new business value. Trough valuation provides good entry point CPIC was listed in December 2009. During 2010 and 1H11, CPIC traded between HK$25-35, which implied forward VNB (value of new business) multiples of about 20x. The counter is now trading at only a high-single-digit VNB multiple, and an undemanding forward price/embedded value of 1.4x. We set our target price for CPIC at HK$32.70 (implying a 27.7% upside potential from the current level) based on the Bloomberg consensus (from 21 market estimates). COMPANY BACKGROUND: China Pacific Insurance (Group) Company is an integrated insurance services provider. The company offers life and property insurance products through its subsidiaries. EARNINGS DATA Year to 31 December 2010A 2011E 2012E 2013E Net profit RMBbn 8.56 9.89 12.42 14.69 Growth YoY% +16.3 +15.6 +25.5 +18.3 EPS RMB 1.00 1.16 1.45 1.72 Growth YoY% +5.3 +15.6 +25.5 +18.3 BVPS RMB 9.34 9.61 10.71 12.11 Growth YoY% +6.1 +2.9 +11.5 +13.0 DPS RMB 0.35 0.37 0.44 0.53 Growth YoY% +16.7 +5.7 +18.9 +20.7 PE x 20.8 18.0 14.3 12.1 PB x 2.2 2.2 1.9 1.7 Yield % 1.7 1.8 2.1 2.6 Source: Bloomberg Note: All prices in this report are based on the 1 February 2012 close -5-
CHINA INSURANCE 2 FEBRUARY 2012 South China Financial Holdings Tel: (852) 2820 6333 Fax: (852) 2845 5765 URL: http://www.sctrade.com E-mail: research@sctrade.com Telex: 69208 SCSL HONG KONG Head office 26/F, Tower I, 28/F, Bank of China Tower, Lippo Centre, 89 Queensway, 1 Garden Road Admiralty Central Tel: (852) 3196 6000 Tel: (852) 2820 6333 Fax: (852) 2536 4608 Fax: (852) 2845 5765 Branches RM1002-03, Nan On Com Bldg Shop 2 G/F, Max Share Centre, Shop 1&2, G/F, Yue Man Centre, Shop A1, G/F, Kar Ho Building, G/F, 108 Chung On Street, 69A Wuhu Street, 373 King's Road, 300-302 Ngau Tau Kok Road, 27-31 Hong Lok Road, Hung Hom North Point Kwun Tong Yuen Long, N.T. Tsuen Wan N.T. Tel: (852) 2330 5881 Tel: (852) 2570 4422 Tel: (852) 2191 2822 Tel: (852) 2442 4398 Tel: (852) 2614 1775 Fax: (852) 2627 0001 Fax: (852) 2793 3000 Fax: (852) 2479 4418 Fax: (852) 2615 9427 LONDON 5-6 Carlos Place, Mayfair, London W1K 3AP, United Kingdom Tel: (4420) 7491 9225 Fax: (4420) 7355 4423 DISCLOSURES: The Research Analyst(s) who prepared the research report hereby certify the views expressed in this research report accurately reflect the analyst(s) personal views about the subject companies and their securities. The Research Analyst(s) also certify the Analyst(s) have not been, are not, and will not be receiving direct or indirect compensation for expressing the specific recommendations(s) or view(s) in this report. We and our affiliates, officers, directors and employees, excluding Research Analyst(s), will from time to time have long or short positions in, act as principal in, and buy or sell, the securities or derivatives (including options and warrants) thereof of covered companies referred to in this research report. IMPORTANT: This report and the information and opinions provided or expressed herein have been prepared by South China Research Limited for itself, its parent, holding, subsidiary, or other associated companies for the information of its or their respective clients only, and has been compiled with reasonable care using data, information, or sources believed to be true, reliable, and accurate at the time of publication. No representation or warranty whatsoever, whether express or implied, is made to the accuracy or completeness or otherwise of this report or any of the contents thereof. South China Research Limited, its parent, holding, subsidiary or, other associated companies and its or their directors, officers, associates, representatives, or employees accordingly do not accept any responsibility or liability whatsoever for any direct or consequential loss or damage of whatsoever nature arising from or as a result of the use, publication, or distribution in whole or in part of this report or any of its contents. The information and opinions contained in this report are or may be subject to change or revision without any notice. South China Research Limited, its parent, holding, subsidiary, or other associated companies or its or their respective directors, officers, associates, representatives, or employees may have positions or otherwise be directly or indirectly interested in the securities mentioned in this report or may buy, sell, or deal or offer to buy, sell, or deal in or with such securities from time to time, whether as principal for its or their own account or as agent or in any other capacity for or on behalf of another person. This report is not, and is not intended to be, nor constitutes any offer or solicitation for the purchase or sale or other dealing in the securities mentioned herein. Copyright protection and other rights exist or subsist in this report, which may accordingly not be used for any other purpose, nor sold, distributed, published, or reproduced in any manner without the express consent of South China Research Limited. This publication is approved for distribution in the UK by South China Securities (UK), a firm authorized and regulated by the FSA. Important: please refer to our disclosures and disclaimers at the end of this report. -6-