>INDIA INSURANCE (MACQUARIE RESEARCH)

Out of the red, into the black
As Indian life insurers emerge into profitability, we move our valuation basis from the opaque new business profits (NBP) to accounting profits.

Exponential growth in profits
All four of the life insurers we cover are expected to break even by FY3/11E. Thereafter, we expect an exponential growth in profits, with ROEs peaking at 35- 40% between FY3/14E and FY3/16E. Key drivers behind this profitability surge:

• Cost/premium ratios will decline at an accelerated rate, helped by aggressive cost-cutting and an improving share of repeat premiums.
• A blow-out in asset management fees, with players showing a 50-68% CAGR over FY09-15. By FY15, these fees will have risen from 9% of revenues to 18% (aggregated for the five companies).

Valuations – very cyclical
We have used a dividend discount model to value the businesses – we believe this is more transparent than the previously used ‘PV of NBP’ method. It isn’t perfect though, and a ‘long-term fair value’ is less relevant because equity market returns (and their secondary impact on sales growth) are an important assumption, which cannot be realistically forecast in a straight line. As with other capital market businesses (such as broking/investment banking), valuations cycle with the markets.

Our positive view of the markets is behind the 9-60% upgrades to the valuations of the five life insurers, whose parents we cover.

Industry growth strong, but not secular
We retain our view that the Indian insurance industry will continue to grow at a strong pace over the medium term, albeit with greater cyclicality than in the past. Growth will still be driven by a combination of India’s demographics, the low share of equity in household savings and the lack of a formal social security framework. While insurance is the most expensive way for an investor to access the markets, the industry’s strong distribution still gives it an advantage over mutual funds.

In our view, the competitive scenario will follow recent trends: Life Insurance Corporation will lose market share to the private sector – and the top five players there will continue to consolidate, with most new players probably struggling.

Reliance Capital, HDFC – best plays
We upgrade our valuations of the lifecos, factoring in the near-term upside we have forecast for the equity market. We also upgrade our ratings for Reliance and Kotak, primarily because of the increase in the lifeco valuations. These valuations are well above long-term fair values, which implies the downside will be high if the markets take an adverse turn. Our favourite plays on the sector are Reliance Capital and HDFC.

To see full report: INDIA INSURANCE