Investment Highlights

• We maintain our BUY call on Hong Leong Financial Group (HLFG) and our fair value of RM19.30/share based on SOP valuation. We make no changes to our forecast.

• We met the management of HLFG recently for updates. The group is staying focused on driving the growth of embedded value (EV) for its insurance business. This will be through changing the product mix by increasing the non-par/par ratio. In general, non-par/investment-linked policies have higher EV margins than ordinary life policies.

• Recall in FY19, the embedded value margin for new business (NBEV) of Hong Leong Assurance (HLA) has improved to 38.5% vs. 32.3% in FY18 while the embedded value for the entity grew 6.4% YoY to RM2.4bil. For new businesses, the non-par/par ratio has risen to 93:7. Nevertheless, for the total book (new and existing insurance policies), the ratio is still low at circa 30:70. There are opportunities to lift the non-par/par ratio to the high 90s for the new business. Also, there is still room for the non-par/par ratio for the total book to gradually rise to the targeted 60:40 through potentially adding on riders to the existing policies.

• We gather that digital initiatives are ongoing to reduce cost, consequently improving margins for the lower yielding margin insurance products/par policies.

• Unlike general insurance where more policies can be sold digitally, transactions for life insurance of HLA as of now are still largely dependent on agents and bancassurance, with only a small percentage transacted online.

• We understand that HLA has around 10,000 agents now. It intends to grow the number to 13,000–15,000 eventually. The focus will be on retaining the more productive agents.

• HLA has made positive changes by acquiring longer term bonds to mitigate itself from the impact of lower interest rates. Efforts have been taken to narrow the difference in the duration gap of its insurance business’ assets and liabilities. We see an increase in financial assets at fair value through profit and loss (FVTPL) securities on HLA’s balance sheet. Owing to this change, any decline in interest rate which will increase the contractual liabilities, will now be mitigated by fair value gains on FVTPL securities in P&L, thus lowering the interest rate risk.

• HLA is ranked 7th in the ordinary life segment in terms of new business regular premium (NBRP) while it maintained its 4th ranking in the investment-linked space. On bancassurance, HLA will leverage Hong Leong Bank’s (HLBB) 254 branches and cross sell to the customers and suppliers of Hong Leong Group.

• There was talk in the market some time back on the potential liberalization of the structure on commission rates payable for agents which are currently capped. However, this has yet to take place. In the event that it happens, we foresee a short-term impact with a likely increase in commission expenses for insurance business before the commission rates taper to equilibrium.

• The outlook for MSIG Insurance (Malaysia), the general insurance arm which HLFG owns a 30% stake indirectly via HLA Holdings, remains challenging in the near term. This is due to the detariffication for fire and motor insurance impacting the underwriting surplus. Potentially, the upcoming phase of the liberalization on fire is expected to continue to pressure the pricing for fire insurance. This will be no different from the challenges faced by other general insurance companies in Malaysia.

• On the general insurance business in Hong Kong under Hong Leong Insurance (Asia), which is 100% owned by HLA Holdings, we understand that the protest against government has impacted the investment income as well as the demand for travel insurance over there. On a comforting note, earnings from HLIA remains insignificant in terms of contribution to the group. The key driver of earnings for the insurance business remains HLA.

• The stock remains a lower cost of entry to gain exposure to HLBB. This is based on HLFG’s market cap of RM20.0bil which is at 16.1% discount to HLBB’s RM23.9bil for a 64.4% stake in the latter.

• For HLBB, we continue to expect decent earnings in the coming 1Q20 results which are expected to be announced on 27 of November together with HLFG’s results. We expect improvement in HLBB’s NIM in 1Q20 from 4Q19 due to the repricing of deposits after the OPR cut of 25bps in May 2019 as well as benign asset quality and stable provisions for the banking entity.

Source: AmInvest Research - 8 Nov 2019