Missed  expectation. After eight consecutive quarters of profits, 3Q15  results plunged  once  again  into  negative  territory.  Loss  totalled  RM20.1m,  bringing 9M15 net profit down to RM50.5m. This lagged our expectation, accounting for a mere 32% of our FY15 forecast. The weaker-than-expected performance was brought  about  by  large  claims  relating  to  the  floods  on  the  East  Coast  of Malaysia and possibly also the aviation tragedies involving local carriers.

YoY,  9M15  net  profit  fell  mainly  on  lower  NEP  and  higher  expenses. Specifically,  the  -7.8%  YoY  drag  on  9M15  net  profit (NP)  was  due  in  part  to declines  reported  in  net  earned  premiums  (NEP)  to  RM1.4b  (-1.5%  YoY)  as gross earned premiums (GEP) stayed flat (-0.2% YoY)and the retention ratio slipped to 89.3% (-1.1ppts). Only the takaful segment (+3.6% YoY) managed a growth  in  GEP,  whereas  the  reinsurance  (-1.2%  YoY)  and  retakaful  (-54.6% YoY) segments recorded declines. Other revenues also registered a decline (-5.5% YoY) this 9M15. Consequently, total income waspushed downwards to RM1.61b (-1.9% YoY).

The  decline  was  further  exacerbated  at  the  net  profit  level  mainly  on  an increase in operating expenses with the expense ratio coming in higher at 34% (+1.5ppts YoY). Another impacting factor was a jumpin the effective tax rate to 38.9% (+6.1ppts YoY).

QoQ, 3Q15 went into the red on aviation and flood claims. On a QoQ basis, 3Q15 saw a net loss due in part to a decline in other revenue to RM40.2m (-22.7%  QoQ).  NEP,  on  the  other  hand,  managed  a  3.7%  QoQ  growth  to RM495.1m.  Hence,  total  income  was  propped  back  up  to  register  a  marginal 1.1% QoQ growth to RM535.3m.

Nevertheless,  the  gain  turned  into  a  loss  at  the  net  profit  level  given  a  large 12.3ppts  QoQ  increase  in  the  net  claims  ratio  to  75%  on  a  few  large  claims relating to the recent floods in Kelantan, Terengganu and Pahang (Dec 2014 – Jan  2015)  and  possibly  claims relating  to  Malaysia  Airline  MH370  and  MH17 (early-  and  mid-  2014).  The  expense  ratio  was  also  higher  to  35%  (1.6ppts QoQ). Both of this elevated the Group’s combined ratio by a whopping 13.9ppts QoQ to 110% causing 3Q15 to register the Group’s first earnings decline in two years.

Increased  regulation  to  spur  JV/M&A  activities?  Moving  forward, uncertainty  looms  on:  (i)  how  the  Group  will  respond  to  the  impending  detariffication  of  the  motor  and  fire  takaful  (and  insurance)  scheduled  for  2016, and (ii) the Financial Services Act 2013 and the Islamic Financial Services Act 2013  (effective  30  June  2013)  requirement  for  composite  takaful  (and insurance) players to split their licenses by 2018.While the jury is still out on whether the former will be beneficial or not to insurance players, the latter will likely  result  in  higher  costs  (in  the  setting  up  of separate  units  with  separate capital requirements). Hence, there may be pressureon the Group to consider a joint-venture or merger and acquisition, which inturn could be a positive rerating catalyst.

GST  could  slightly  dampen  growth  but  unlikely  to  be material. There  is also the goods and services tax (GST) which is scheduled to take effect in a few days’ time (on 1 Apr 2015). The GST could possibly dampen sentiment and result in a pull-back in spending, which may impacton insurance sales as the majority  of  insurance  products  will  be  subjected  to GST.  However,  we  are expecting  premiums  to  grow  given  a  greater  awareness  of the  importance  of insurance,  especially  with  the  cost  of  living  going up.  Furthermore,  fire  and motor insurance are compulsory.

Trading buy with a fair value of RM4.35.  In short, FY15 was fraught with a couple of notable disasters which had impacted on the Group’s performance. Moving  into  FY16,  we  are  anticipating  a  rebound  in  net  profits  with  a  more sustainable claims ratio of <70%. Having said that,premiums growth could be slightly muted owing to the implementation of the GST. In light of this, we cut our  FY15/16  forecasts  by  42/7%,  leaving  us  with  a  lower  fair  value  (FV)  of RM4.35  (from  RM4.60).  Our  PB/PE  ratios  remains  unchanged  at  0.6/6.2x which are 1SD  above the Group’s 3-year price multiple bands. Nevertheless, these price ratios are still much lower than the industry average (3.1/17.4x). In this respect, we reiterate our TRADING BUY call on the counter.

Source: Kenanga Research - 26 Mar 2015