Have China's Insurers Getting Expensive -- Barron's Blog

        By Shuli Ren
        Propelled by the People's Bank of China's interest rate cut on November 21, China's insurance companies had such a rally. In the last three months, China Life ( 2628.HK) rose 41.8%; China Pacific ( 2601.HK), 34.1% ; Ping An Insurance ( 2318.HK), 42.6%; New China Life ( 1336.HK), 63%. By comparison, international insurer AIA Group ( 1299.HK) gained only 8.7%.
        China's insurance companies do have a good industry outlook. Beijing wants to become a "limited liability" government and is actively encouraging the insurance companies to get Chinese and the Chinese businesses covered. Since Beijing wants its nascent insurance industry to cover 5% of China's GDP by 2020, we can expect 14.3% annualized growth in the next five years, assuming 7% nominal GDP growth, reckons HSBC.
        But how to value insurance companies is the wild card. There are three ways to value an insurance company, a plain-vanilla book-value based Gordon growth model, an enterprise value based Gordon growth model, which gives higher valuations, and an appraisal approach, which gives the highest valuations. The appraisal approach values a company in terms of its franchise value and an embedded growth option, a dynamic programming method used in finance to justify high asset prices.
        In times of distress, investors would value insurance companies based on book. But when times are good, appraisal approach is in fashion. Intuitively, this makes sense, as investors in bad times see little of the so-called "growth options." The enterprise value based growth model is the middle ground.
        So here is the dilemma: Using the plain-vanilla book-value method, Chinese insurance companies have already gone too expensive. But they still have a big upside if you include growth options. "Some Chinese insurers have traded on life NBV value multiples of more than 80x (i.e., share price = life EV + 93 x NBV) versus a range of 3.3-19.8x today," wrote HSBC analyst James E Garner and team today.
        For instance, China Life currently trades at about 1.4 times enterprise value. Under the plain vanilla method, it should be valued at only 0.67 times, whereas the appraisal approach values China Life at 2.35 times. We are speaking of a 52% downside on one end and 70% upside on the other. Same situation goes for the rest of the industry.
        So what to do with the insurance stocks? HSBC took a fairly conservative approach and decided to go with the middle ground - the enterprise value Gordon model. In that case, Ping An Insurance has a 22% upside; China Pacific, 29% upside; China Taiping, 26%. China Life and New China Life, by comparison, have much smaller upside. As such, HSBC has a Buy rating on China Pacific with a price target of 50 Hong Kong dollars, China Taiping with a price target of HK$29, and Ping An Insurance with a price target of HK$106. The bank downgraded China Life and New China Life to Neutral today.
        Separately, UBS also downgraded New China Life to Neutral with a price target of HK$46 today.
        But market largely ignored the analysts' worryings - a sign that they still trade as a block and are in the process of re-rating. China Taiping jumped 7.8%, China Pacific gained 4.7%, Ping An Insurance rose 3.9%, China Life Insurance, which got the HSBC downgrade, advanced 3.7%. Only New China Life was little changed. AIA Group fell 1% after investors moved their money back into Chinese insurers today.
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        (END) Dow Jones Newswires

        January 19, 2015 22:28 ET (03:28 GMT)

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