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  • Stock Recommendation | ICICI Lombard - SELL - Target price : 650

    Publish date: OCTOBER 22, 2018

    In a sweet spot. ICICI Lombard’s robust 2QFY19 performance was driven by higher profitability in motor TP and a lower expense ratio largely in the motor business. We expect the business to remain in a sweet spot in the near-term supported by industry tailwinds, viz. better pricing in health and higher volumes in motor. While demand drivers remain strong, competition may partially offset the benefits- a risk, ignored by the Street. We revise estimates, retain SELL and revise TP to Rs650 (up from Rs620).

    ICICI Lombard reported 44% yoy PAT growth to Rs2.93 bn in 2QFY19. Net earned premium rose 23% yoy. Decline in commissions and opex ratio by 200 bps and claims ratio by 190 bps led to a reduction in underwriting loss (Rs215 mn versus Rs815 mn in 2QFY18); combined ratio was 101%, down 190 bps yoy. Investment income was up 19% yoy on the back of 15% growth in the investment book as calculated investment yield declined 30 bps to 9.4%.

    Picking the right segments, low losses in Kerala. ICICI Lombard has demonstrated its ability to cherry pick the appropriate segments and curtail expense ratios, leading to superior profitability. The company limited its losses in Kerala (a state in which its motor loss experience is worse than the rest of the country) to Rs0.25 bn, just 1.25% of the total industry wide loss estimate of Rs20 bn. Its close association with motor OEMs will make it a beneficiary of the recent motor TP regulations.
    Despite positive macro, a few challenges in business and forecasts. While positive macro drivers are in place, we find two key changes in business dynamics that makes it challenging to forecasts viz. change in claims experience and strong competition. (1) Claims experience may be significantly different when markets expand due to regulatory compulsions. For example: increase in personal accident insurance to Rs1.5 mn from Rs0.1 mn may lead to higher claims which were otherwise ignored. (2) Competition will likely pass on some of the benefits of long-term motor TP policies (higher volumes and float income) especially in light of concerns of lower volumes by OEMs; the OD attachment rates on longterm TP policies are difficult to predict as well. Notably, the benefits of IRDA guidelines on restricting dealer commissions in motor insurance (MISP guidelines) seem to be almost fully passed on to customers in about 4-5 quarters of implementation.
    Street is ignoring cyclicality of business. ICICI Lombard has outperformed most BFSI stocks on the back of strong industry tailwinds which are expected to drive high mediumterm growth. Current rich valuations are however ignoring cyclicality in business and risk of higher competition, as discussed above. We hence retain our SELL rating on the stock with TP of Rs650 (up from Rs620 to reflect higher medium-term growth); at our TP the stock will trade at 21X earnings and 4.5X book FY2020E, juxtaposed to 24% RoE and 21% earnings CAGR during FY2019-21E.

    Motor business is the key driver
    Motor business. Motor has driven 80% of its operating profit (72% in 1QFY19 and marginal loss in 2QFY19) in 2QFY19. Improvement in pricing in the motor TP segment coupled with a higher provision in the base year narrowed the loss ratio to 90.5% from 111.4% in 2QFY18; loss ratio in motor OD increased to 59.7% from 54% in 2QFY18 (though lower than 62.9% in 1QFY18) as the benefits of the MISP guidelines seemed to have been passed on to customers. After defocusing on the CV segment, the company is once again picking up profitable pockets in CVs, though CVs remain low at 19.9% as compared to over 40% for the industry. The profitable car segment contributed to 50% of its business in 1HFY19. The new motor insurance guidelines (compulsory three year motor TP for new cars and five years for new two wheelers) will likely increase attachment rates for OD as well. In the earnings call, management highlighted that about 50% of its motor business is for new vehicles (which will likely benefit from the above); attachment rates in two-wheelers have so far been impressive at 40% (though too early to extrapolate this) while in cars are less than 10%. Pricing in this segment can reduce significantly due to higher volumes (increased pool benefits), strong competition and higher float income.
    Health. ICICI Lombard has delivered 36% growth in net earned premium, shifting its focus a bit to the corporate (up 82% yoy) while retail health was weak (down 15% yoy). Its loss ratio increased 960 bps yoy to 84.9% (stable qoq). Within the corporate business, pricing has been better in SME and mid-corporate segments. Large corporate segment remains unattractive even as prices have improved here as well.
    Crop. Net premium in the crop was up 14% yoy driving 13% of its premium. Loss ratio in this segment increased to 117% (stable qoq) from 106.3% in 2QFY19. Claim payout in this segment was one of the key drivers of reduction in qoq investment pool. While ICICI Lombard is going slow in this segment, it is open to look at profitable pockets especially in well-governed states like Maharashtra and MP; it covered 4 states and 30 districts in FY2019 versus 7 states and 56 districts in FY2018.

    Improvement in combined ratios and higher investment float in the forecasts
    We forecast ICICI Lombard’s combined ratio to improve to 98.5% in FY2019E (100.2% in FY2018 and 101.1% in 2QFY19) due to lower expense ratios (down 300 bps during FY2018-20E) and marginal reduction in loss ratios. We believe that tailwinds in the motor business coupled with high growth in health (better pricing in corporate segment) will drive 23% CAGR in net earned premium. High growth in the investment pool due to an increase in URR in the motor segments will drive 25% CAGR in investment income.

    Definitions of ratings

    BUY - We expect this stock to deliver more than 15% returns over the next 12 months.
    ADD - We expect this stock to deliver 5-15% returns over the next 12 months.
    REDUCE - We expect this stock to deliver -5-+5% returns over the next 12 months.
    SELL - We expect this stock to deliver

    Our target prices are also on a 12-month horizon basis.

    Other definitions

    Coverage view. The coverage view represents each analyst's overall fundamental outlook on the Sector. The coverage view will consist of one of the following designations: Attractive, Neutral, Cautious.

    Other ratings/identifiers

    NR = Not Rated. The investment rating and target price, if any, have been suspended temporarily. Such suspension is in compliance with applicable regulation(s) and/or Kotak Securities policies in circumstances when Kotak Securities or its affiliates is acting in an advisory capacity in a merger or strategic transaction involving this company and in certain other circumstances.
    CS = Coverage Suspended. Kotak Securities has suspended coverage of this company.
    NC = Not Covered. Kotak Securities does not cover this company.
    RS = Rating Suspended. Kotak Securities Research has suspended the investment rating and price target, if any, for this stock, because there is not a sufficient fundamental basis for determining an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon.
    NA = Not Available or Not Applicable. The information is not available for display or is not applicable.
    NM = Not Meaningful. The information is not meaningful and is therefore excluded.

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