INVESTMENT HIGHLIGHTS

• FY18 core profit results came in within expectations

• Marginal growth in top and bottom line amid challenging period

• Underwriting profitability hit by higher claims and commission expenses

• Earnings forecast for FY19 revised downward by -6.41% to RM335.0m (from RM358.0m) in view of the probable increased competition in its fire insurance business

• Maintain NEUTRAL with revised TP of RM16.10 (previously RM16.70)

Within expectations. LPI Capital reported FY18 core earnings of RM314.0m, posting a marginal increase of +1.0%yoy. Accordingly, this translated to 103.1% and 101.4% of ours and consensus’ full year estimates. The group also posted a slight growth of +1.1%yoy in its 4QFY18’s core earnings to RM84.0m.

Marginal growth in top-line. LPI Capital’s FY19 operating revenue improved by +2.9%yoy to RM1,513.7m. This was mainly attributable to the group’s FY18 gross earned premiums (GEP), which grew marginally by +2.4%yoy to RM930.8m amid uncertain market conditions and the ongoing liberalisation of Fire and Motor insurance. However it was also worth noting that the group’s net earned premiums (NEP) has increased by +9.5%yoy to RM930.8m due to higher retention rate and lower claims ceded to reinsurer. While this might initially be seen as a positive sign for the group to retain more risks and book higher NEP, we opine that this it is a risky strategy. This is because the group could face with reduced underwriting profitability should the claims incurred increase to a higher level.

Combined ratio deteriorated. The group’s combined ratio recorded a net increase of 2.9ppts yoy, from 65.0% in FY18. This was partly due to the rise in the group’s claims ratio and commission ratio, which grew by +2.4ppts yoy and +1.1ppts yoy to 40.9% and 6.9% respectively. This translated to a -2.9ppts yoy drop in the group’s FY18 underwriting margin to 32.1%. The increase in commission ratio was mainly due to the lower reinsurance commission received as the group sought to retain more risks on their own. Nonetheless, LPI Capital remains a steady and profitable player in the general insurance segment as the industry’s combined ratio stood around 91% and whereas the group stood at 67.9% in FY18.

Underwriting profit declined slightly. Its overall FY18 claims ratio experienced an increase of +2.4ppts yoy from 38.5% of the same period last year as the net claims incurred by motor and miscellaneous segments rose +12.4%yoy and +45.8%yoy respectively. This translated to a negative growth rate of -0.76%yoy of underwriting profit to RM303.5m in FY18. The declining growth was mainly driven by management expenses, climbing +6.6%yoy while moderated by Fire and MAT due to lower net claims incurred in FY18.

Earnings estimates. We revised the earnings forecast of FY19 downwards from RM358.0m to RM335.0m, representing a -6.41%yoy adjustment in view of the increased competition in the industry upon liberalisation of both motor and fire insurance and greater pricing pressure.

Dividend. The group announced 42 sen second-interim dividend, to be payable on 27 February 2019. Together with its first-interim dividend of 26 sen, the total dividend pay-out for FY18 will be amounted to RM270.9m (an increase of 13.3% from FY17 dividend pay-out of RM239.0m). However, this represented a lower pay-out ratio of 86.3% (FY17: 92%) of the group’s net profit compared to the prior year.

Target Price (TP). In light of our earnings revision, we adjust our TP to RM16.10 (from RM16.70). We peg its

FY19F Core EPS to PER of 19x (5-year historical average).

Recommendation. The general insurance industry is on a downtrend as the industry is facing structural change due to the liberalisation of motor and fire insurance. These segments constitute about 31% and 42% of NEP of LPI Capital where fire insurance alone contributes around 64% of the group’s underwriting profit. Recall, the final phase of the fire insurance liberalisation will likely take place in 2H19 after the review by BNM in June. The effect would be that more competitively-priced products released by insurers to gain market share which will put pressure on margin. Meanwhile, general takaful segment is gaining traction and growing at a faster pace than conventional, which might increase the competition in this segment. Nonetheless, as a market leader in the fire insurance segment and a lowcost insurer as well as having strengthened distribution channels, the group continue to look at expanding its business portfolio to compensate for the compressed margin. The group also has a ratio of cash flow from operating activities to net income of 121.5% (RM381.4m/RM314.0m), indicating sufficient cash flow to meet its obligations and even pay dividend to its shareholders. All in, we maintain our NEUTRAL stance on LPI Capital.

Source: MIDF Research - 30 Jan 2019