• We maintain BUY on Hong Leong Financial Group (HLFG) with an unchanged fair value of RM17.20/share based on SOP valuation. We continue see the stock as attractive due to: i) it being a cheaper entry for gaining exposure to Hong Leong Bank (HLBB); and ii) its undervalued insurance business. No revision in our earnings estimates.
• Management provided updates on the insurance business over a virtual meeting last week. In 1Q21 (July–Sept 2020), we understand that growth of gross premiums has picked up pace modestly year-on-year with improvements in premiums from agents and the bancassurance channel after the partial lockdown (MCO) in March 2020. In 1HCY20 (Jan–June 2020), key insurance operating subsidiary Hong Leong Assurance’s (HLA) growth in premiums was impacted by the MCO although it still outperformed the industry’s. Its regular and single premium contracted by 16.4% YoY and 13.5% YoY, smaller than the industry’s decline of 20.8% YoY and 26.3% YoY respectively in 1HCY20. Meanwhile, agency premium growth registered a decline of 16.8% YoY vs. the industry’s -24.0% YoY.
• We take comfort that the group has not received many requests from the insured to defer premiums up the 3 months under the Covid-19 relief programme. Also, it has not seen many cases requesting for life insurance premiums to be lowered. Hence, the persistency ratio is likely to stay well above 80% with not much of downside risk from the 87.1% in FY20.
• HLA’s investment portfolio comprised 80% cash and bonds and 20% equity. 95% of the equity investments are in domestic stocks with the remaining 5% in overseas shares. The investments are largely classified as FVTPL securities.
• With the stock market still volatile, the marked-to-market equity investments are likely to still have some impact on the earnings of HLA. Meanwhile, interest rate risk on HLA’s earnings is manageable with a slight negative to the group’s earnings in the event of a decline in MGS yield. This is due to the lower duration of assets vs. liabilities. Hence, when interest rate declines, the increase in contractual liabilities will be slightly higher compared to the rise in the valuation of the insurance business’ assets. HLA has already lengthened the tenure of its investment securities to more than 15 years. This has narrowed the duration gap between the insurance business’ assets and liabilities. Conversely, any increase in interest rates will be marginally positive to HLA’s earnings.
• Movements in interest rates will only impact HLA’s non-par and shareholders’ funds. It will not affect the par and investment-linked funds

• We understand that claims for life policies have continued to stay low.
• Recall that the new business embedded value (NBEV) of HLA slipped 26.2% YoY to RM147.8mil in FY20 from RM200.3mil in FY19 attributed to changes in assumptions to reflect the lower interest rate environment. The group is targeting to raise HLA’s NBEV to RM200mil in FY21. This is premised on: i) no further rate cuts after the 25bps OPR reduction on 7 July; ii) no deterioration in the valuation of equity investments; and iii) stronger pick-up in growth of new business regular premiums (NBRP).
• We understand that the contribution of premiums derived from the digital channels is still small compared to other distribution channels (agency and bancassurance).
• Profit contribution from the insurance subsidiaries – Hong Leong MSIG Takaful, Hong Leong Insurance (Asia) and HL Assurance – remained insignificant. The general insurance business profits of Hong Leong Insurance (Asia) in Hong Kong were impacted by lower demand for travel insurance and the marked-to-market impact on equity investments. Meanwhile, the general insurance business of Hong Leong Insurance (Asia) in Singapore has turned around from losses to marginal profits.
• The capital adequacy ratio (CAR) of HLA is still healthy at above 130%.
• NIM of HLBB, the group’s commercial banking business, is likely to improve QoQ in 1Q21 supported by the repricing of deposits to incorporate the recent OPR cuts. Meanwhile, loan momentum is expected to be sustained in 1Q21.
• We expect HLBB’s NOII in 1Q21 to be decent underpinned by a strong treasury income (gains from disposal and marked-to-market gains on securities). In regards to the share of profits from the associate Bank of Chengdu (BOC), we expect it to be still holding up in 1Q21.
• In FY20, HLBB reported a credit cost of 22bps. In 1Q21, we expect a further top-up in provisions (management overlay). The increase in conservative provisioning for the impact of Covid-19 is likely to partially offset the topline improvement of HLBB in 1Q21. For FY21, we maintain our credit cost expectation of 25bps.
• For FY21, management does not foresee much challenge in matching at least the 38 sen/share dividend of the last financial year.

Source: AmInvest Research - 21 Oct 2020