Staying Focused on Key Expertise

Despite a potential moderation in the general insurance industry in 2H18, we believe that LPI Capital’s earnings and cashflows will remain solid owing to its established presence in the industry. Apart from focusing on fire risk-underwriting (its key expertise), LPI is establishing more comprehensive insurance products and beefing up its exposure in the miscellaneous segments. Though LPI saw an overall higher net claims in 1H18 (+24.6% yoy) and a spike in 1Q18 net claims ratio to 47% (against company’s norm at 40%), we believe that it will ease in 2H18 as management exercises more caution in motor risk-underwriting. Reiterate BUY, price target unchanged at RM18.90.

LPI Remains Focused on Underwriting Fire Policies (highest Margin)

Fire policy-underwriting remains the LPI Group’s forte and it will continue to focus on this profitable general insurance segment, which contributes 43% to 1H18 net earned premium and 67.4% to 1H18 underwriting profit. Though its general insurance peers are competing through price discounts, LPI’s management has introduced more comprehensive fire policies and relied heavily on its industry track record and its extensive distribution network.

Beefing Up Exposure in Miscellaneous Insurance Segment

In order to counter the slower motor insurance underwriting results, LPI has taken steps to beef up its exposure in the miscellaneous insurance segment (accounting for 22% of 1H18 underwriting profits) which includes liability insurance, employee benefits and personal accidents.

2H18 Results Are Expected to be Better Vs. 1H18 on Lower Net Claims

Based on management’s feedback, the higher motor claims in 1H18 (80.6% vs. 68.9% in 1H17) was unexpected (due to some isolated cases) and thus, believes that the high claims may ease in the subsequent quarters. As such, we keep our 2018-20E forecasts unchanged.

Reiterate BUY, Price Target Maintained at RM18.90

We maintain our FY18-20E earnings forecasts for LPI, which are underpinned by the following key assumptions: i) GWP growth at 2-5%; ii) net earned premium growth at 5-5.6%; iii) net claims ratio at 38-39%. We reiterate our BUY rating on the stock, with a Price Target of RM18.90 based on a 3.2x P/BV target on 2019E’s BVPS. Downside risks: price competition, spike in claims, higher fraud cases and weaker premium growth.

Withstanding Industry Challenges

LPI Remains Focused on Underwriting Fire Policies (highest Margin)

The general insurance industry is expected to stay flattish in 2018 vs. 2017 as a result of the weak industry outlook from the marine, aviation and transit (MAT) segment, though both the motor and fire insurance segments are expected to stay resilient in 2018. Based on PIAM’s (Malaysia General Insurance Association) findings, the Malaysian general insurance industry saw stagnant growth in 2017 as growth in the motor insurance (+1.9% yoy) and the fire insurance (+4.2% yoy) sectors were mitigated by a 14.6% yoy decline in the MAT sector.

Meanwhile, as for LPI Capital, fire policy-underwriting remains the Group’s forte and it will continue to focus on this profitable general insurance segment, which contributes 43% to 1H18 net earned premium (generally higher than the industry share of circa 19-20%) and 67.4% to 1H18 underwriting profit (Fig 1-2).

The high share of LPI’s fire insurance underwriting profit was underpinned by a lower claims ratio which stood at 14% for 1H18. Based on results in the past 5 years, LPI’s fire policies claim ratios ranged from mid to highteens against the industry ratio of between 27.6%-29.4%.

Based on Fig 3, which shows the segmental growth rate in terms of gross written premium (GWP), the fire segment has remained resilient from FY16 until 1HFY18 (at growth rate between 6-7.5%), though has come down from a high teen growth prior to FY16. The motor segment’s GWP was seen picking up in 1HFY18 after a period of slower auto sales, though remains modest. The miscellaneous segment grew at 32.5% yoy in FY17 and was at 19% yoy as at 1HFY18 due to LPI management’s focus to grow this segment which is also highly in demand. Meanwhile, the MAT segment has been seeing negative growth since FY15 and may remain in the doldrums owing to weakness in the oil and gas as well as the shipping sectors.

Approximately 40% of LPI’s fire insurance premium underwritten (mainly commercial and industrial) are cross sold related-party transactions to Public Bank’s customers (currently LPI owns 1.1% and shares a common shareholder). At the group level, premiums driven by Public Bank’s customers account for approximately 20% of LPI’s GWP.

Differentiating Against the Industry – Products, Distribution Network

LPI has through the years of its industry experience (more than 55 years), continued to focus on improving products and services. For instance, though the general insurance peers are competing through price discounts, LPI differentiated itself with more comprehensive fire policies as well as better customer relationship management (identifying gaps in coverage and better claims experience).

LPI also relies on an extensive distribution network which at the core is its substantial agency force, in-house marketing team and IT system (which identifies opportunities through data analytics and optimizes processes).

Beefing Up Exposure in Miscellaneous Insurance Segment

In order to counter the slower motor insurance underwriting results, LPI has taken the step to beef up its exposure in the miscellaneous insurance segment (accounted for 22% of 1H18 underwriting profits, Fig 2) which includes health insurance, liability insurance, employee benefits, pecuniary insurance, trade credit, engineering & workmen’s compensation and personal accidents.

Some major insurance projects secured are such as the East Coast Rail Link (ECRL) and the LRT3. At this juncture, the policies are still in-force and in the event of a scale down, there will be a refund of the premium. Nonetheless, as the retention rate of these projects are less than 5%, the impact on LPI’s net earned premium is relatively minimal.

2H18 Results Are Expected to be Better Vs. 1H18 on Lower Net Claims

Based on management’s feedbacks, the higher motor claims in 1H18 (80.6% vs. 68.9% in 1H17) was unexpected (due to some isolated cases) and thus, believes that the high claims may ease in the subsequent quarters. The industry claims ratio for motor policies has been on a declining trend from 82.7% in 2008 down to 70.4% in 2017.

As such, we believe that there is no necessity to revise our assumptions, and hence we keep our 2018-20E net profits unchanged.

Valuation & Recommendation

Reiterate BUY, Price Target Maintained at RM18.90

We maintain our FY18-20E earnings forecasts for LPI, which are underpinned by the following key assumptions: i) GWP growth at 2-5%; ii) net earned premium growth at 5-5.6%; iii) net claims ratio at 38-39%. We reiterate our BUY rating on the stock, with a Price Target of RM18.90 based on a 3.2x P/BV target on 2019E’s BVPS.

Though the implied 5-year P/BV multiple average stood at 2.6x, with a range from as low as 2.0x to as high as 3.1x, our target valuation of 3.2x (based on a Gordon Growth Model) is higher due to LPI’s ability to maintain its core ROE at mid-teens against a more liberalized market and greater industry competition. Meanwhile, we also take into account some of LPI’s key strengths such as its ability to leverage on tie-ups with various parties such as agencies (45% of portfolio contribution), banks (20%) and global partners such as Fubon Financial and the RSA Insurance Group (whereby has helped LPI in securing underwriting contracts with various multi-nationals).

Therefore, we believe that applying historical P/BV averages will not justify how LPI could improve its profitability in the coming years based on its competitive advantage and key strengths.

Downside risks: price competition, spike in claims, higher fraud cases and weaker premium growth

Source: Affin Hwang Research - 24 Jul 2018