We are maintaining our rating on Pacific & Orient (“POB”) at OUTPERFORM. Our target price is maintained at RM1.80, which factored in the company’s higher shareholders fund after the recent disposal by it of a 49% interest in P&O Insurance (POI), giving it a new sustainable ROE of 12% and a potential total upside of 38% for the stock over the next 12 months. P&O arguably is in the most profitable segment of the business, i.e. motorcycle insurance. Given that its claims provisioning has been likely overly provided, we expect an allowance write-back in FY13 and this should reduce doubts over its claim quality. Besides, management indicated that it would be comfortable with an internal core capital ratio of 170%. As such, there could be an upside risk to our dividend forecast, which would allow for a reduction in its internal core capital ratio to 170% from the estimated 200% by end-FY13 according to management. P&O’s valuations of 6.9x FY14 PER & 0.7x P/BV are undemanding together with a high 5.7% net dividend yield (assuming a 40% payout). We expect investors to increasingly favour P&O. We are maintaining our P&O TP at RM1.80 based on 1.0x its FY14 BV.

Superior claim quality. P&O is arguably in the most profitable segment of the business, i.e. motorcycle insurance. The claims for all its general insurance segments here are lower than the industry levels. On the overall, P&O’s claim ratio of 44% compares favourably with the industry’s average of 75%. Given its prudence practices in claim provisioning, we expect the group to likely write back some of its allowances in this year, which should lead to a lower-than-expected claim ratio than our forecast of 50%. Having met management recently, we understand that the group’s claim ratio is still improving and likely to decline to 40%. We expect investors to increasingly favour P&O as they begin to have greater confidence in its claim quality.

Dividends could surprise on the upside. Post the 49%-stake disposal in POI, P&O has recently announced a special dividend of 15 sen/share. On top of this, we believe that the group has the capacity to further return more of its core capital to shareholders. Management indicated that it would be comfortable with a 170% Internal Core Capital Ratio (ICAR) to comply with BNM’s Risk-Based Capital Framework vs. the actual 173% ratio recorded as at 31 Dec 2012. The 170% ICAR is a comfortable level to match its premium growth rate of in the mid singledigit over the next few years. Our dividend forecast assumed a conservative payout ratio of 40% but there could be an upside risk to our forecast should management fail to identify any investment targets and decide to return the excess capital to shareholders.

Meanwhile, the group is looking for proposals to improve the liquidity and marketability of POB shares. We think that another share split exercise is possible in this respect. Recall that in 2010, the group had split its shares at a ratio of 1:1 then. We will view the share split move positively if it happens. Capital management will be the next price catalyst for the stock in our view.

OUTPERFORM. P&O’s current valuations of a PER of 6.9x and a P/BV of 0.7x is supported by its high dividend yield of 5.7%. The stock now offers a higher >38% in potential total return (32% capital gain and 5.7% dividend yield). We are thus maintaining our OUTPERFORM rating for now.

Source: Kenanga