Investment Highlights

• We maintain our BUY call on Hong Leong Financial Group (HLFG) with an unchanged fair value of RM21.50/share based on SOP valuation.

• Guoco Group Limited (GGL) owns 25.4% stake in HLFG. On 29 June 2018, it was announced that GuoLine Overseas Limited (GOL), the offeror together with the concert parties holding 71.88% and 2.95% stake in GGL respectively will acquire the remaining 25.17% of the issued shares in GGL which they do not own from the minority shareholders (see Exhibit 3). This will eventually privatize GGL and delist GGL from the Hong Kong Stock Exchange (HKEX) by the end of Nov 2018 (refer Exhibit 4).

• The minority shareholders of GGL will be entitled to receive HK$135 per share or a total consideration of HK$12.5bil. This values both the shares in GGL directly as well as their rights to HLFG shares as shareholders of HLFG. One GGL share will be entitled to 0.8847 HLFG share. Each of the minority shareholders has an option to receive the entitled payments either in: a) All cash, comprising: i) cash payment equivalent to 0.8847 HLFG share multiplied by the VWAP of HLFG share at the date to be determined; and ii) remaining balance in cash (cash alternative) or b) Combination of cash payment and HLFG share to be distributed as special dividend (by way of distribution in-specie). This will comprise: i) the receipt of 0.8847 HLFG share which the value is based on VWAP of HLFG share at the date to be determined and ii) remaining balance in cash. Up to 291,117,471 shares in HLFG could be distributed as dividends (scrip alternative).

• Assuming all minority shareholders elect to receive their entitlements under the all cash alternative, Hong Leong Group’s shareholdings in HLFG will be reduced by 6.3%. Correspondingly, it will raise the minority interests stake in HLFG by the similar percentage (see Exhibit 2). This will improve the free float of HLFG from 22.6% to 28.9% (+6.3%).

• As most of the minority shareholders in GGL are institutional investors, they are likely to opt for the all cash alternative. For these shareholders, the offeror (GOL) will arrange for third-party investors to take up their HLFG shares.

• We are positive on the privatisation exercise as it is likely to improve the liquidity of HLFG’s stock. Also, there will be an increase in the weightage of HLFG shares in the KLCI to circa 1.0% from the present 0.8% (+0.2%).

• From our perspective, the privatisation of GGL will not affect the number of shares in HLFG. The changes will largely impact the level of shareholding above HLFG. Also, the valuation of the stock will remain intact and there will not be any significant impact to the minority interest on HLFG’s P&L and balance sheet.

• HLFG recorded a 5-year CAGR of 5.1% (FY13 to FY18) on its earnings with an improved ROE of 11.0% in FY18. This was supported by improved profits of Hong Leong Bank with a stable asset quality.

• Recall for its insurance division, HLA’s topline was subdued with a contraction of 2.0%YoY on gross premiums. FY18 was slower for the growth of new business regular premiums (-8.3%YoY) attributed to the slowdown in economy and the slower switch to the non-par/investment linked products which have higher embedded value margins. HLA’s persistency ratio has declined to 77.5% in FY18 (FY17: 85.4%). On a comforting note, the new business non-par/par ratio has continued to rise to 89:11 in FY18 from 56:44 in FY17 which has in turn contributed to the improvement in HLA’s earnings. This has raised HLA’s overall book non-par/par ratio to 40:60. HLA’s new business embedded value has increased by 24.3% in FY18 and management aims to raise this to 30.0% in the near term. The number of agents for HLA has declined to 9,426 as at the end of FY18 (FY17: 11,113 agents).

• Meanwhile, we understand that the earnings contribution from MSIG, 30% owned by HLA Holdings, the general insurance business will be slower in 2018 and 2019. This will be due to the pricing pressure from the detariffication of motor and fire insurance.

• As at the end of 4QFY18, HLFG’s consolidated CET1 ratio, Tier 1 and Total capital ratio stood at 10.230%, 11.044% and 13.143% respectively.

Source: AmInvest Research - 9 Oct 2018