LICI: FY22 fair valuation around 520 but may scale 1075 by FY: 23-24

As the pandemic has turned into an endemic, it should help LIC profitability; also COVID scare will help new business

India’s biggest IPO LICI (LIC) was launched in mid-May, in which the promoter- the Government/President of India raised around Rs.20.557B by selling 3.50% of the stake to the public at Rs.949.00 per share with an additional discount of Rs.45.00 to retails, eligible LIC employees and Rs.60.00 for LIC policyholders. In other words, general retail investors got the LICI share at Rs.904.00 and Rs.889.00, while institutional investors were allotted at the upper band of the IPO price; i.e. Rs.949.00.

Subsequently, LICI was listed on 17^th May at Rs.867.20; i.e. over -8.5% to the upper band of IPO price of Rs.949.00; on listing day, LICI also made an intraday high and around Rs.920.00 and Rs.860.10 respectively before closing around Rs.872.70. Eventually, on Friday (17^th June), LICI made a low around 651.00 before closing around 654.55; i.e. plunged over -31% in around 30-days primarily on negative global cues amid the concern of hotter U.S./global inflation, faster Fed/global tightening and resultant synchronized global stagflation or even an outright recession.

In the same period, LICI peers like HDFC Life gained around +1% but also lost almost -59% from the lifetime high of around 776 to the Russia-Ukraine war low of 497. On Friday (17^th June), HDFC Life closed around 552. Similarly, SBI Life slumped over -22%, while ICICI Pru also tumbled over -40%. At the same time in late Mar’20, HDFC Life made COVID low around 340, SBI Life around 519, and ICICI Pru around 226. So these stocks have also made a phenomenal rally post-COVID low in line with overall Wall Street as well as Dalal Street.

LIC is the largest insurance provider company in India. It has a market share of above 66% in new business premiums. The company offers participating insurance products and non-participating products like unit-linked insurance products, saving insurance products, term insurance products, health insurance, and annuity & pension products.

As per LICI IPO DRHP, as of 30^th Sep’21, LIC has a total AUM of Rs. 39T, almost equivalent to India’s real GDP. LIC operates through 2048 branches, 113 divisional offices, and 1,554 Satellite Offices. It operates globally in Fiji, Mauritius, Bangladesh, Nepal, Singapore, Sri Lanka, UAE, Bahrain, Qatar, Kuwait, and the U.K.

Pros of LICI:

·         LIC is synonymous with insurance in India and has a robust pan-India distribution network in every corner of the country

·         Leading insurance provider company in India and fifth largest global insurer by GWP

·         LIC is a part insurance and part investment products company. LIC plans are a combination of insurance and investment with a guaranteed return

·         LIC has over 1.35M agents who bring most of the new business.

·         LIC plans offer 'fixed returns' along with life insurance coverage. This makes it easy to sell by agents and brings peace of mind to the insurers and conservative policyholders

·         LIC has very high public confidence/trust for both life insurance as well as investment done with them

·         LIC has an AUM of around Rs 39T, almost equivalent to India’s quarterly real GDP.

·         LIC AUM is more than the entire MF industry combined

·         LIC invests funds across stocks and bonds. LIC owns 4% of all listed major stocks in India and more government bonds than the RBI

·         A range of life insurance products to meet the varied insurance needs of individuals

Cons of LICI:

·         LIC has poor new business/policy growth as it continues losing market share to private insurance players, especially in urban areas

·         Weak digital presence

·         The margin in insurance + investment products is low

·         Being a PSU PPT (Plunge Protection Team) entity and having a role as India’s leading domestic financial institution (DII), not all investment decisions are based on pure merit in the best interest of shareholders

·         In FY21, LICI has made a bad investment of around Rs.20B government pressure for political reasons based on public interest rather than shareholders

But LIC is also gradually shifting its focus toward profitable insurance products, which may support operating margins and improvement in persistency ratios going forward. This along with very low insurance reach in India, growing income of the upper-middle class, and growing interest in life insurance products after COVID should support all major Life insurance companies including LICI, which has over 61% of the market share in India (new business premium).

Also, LIC launched its first app ANANDA (Atmanirbhar Agents New Business Digital App) in Nov’20 for digital solutions. In any way, a vast population of semi-urban/rural India still depends heavily on their LIC agents for not only insurance needs, but also any other financial products/solutions.

There is an issue of VNB (Value of New Business) margin, low digital & millennial penetration, and IDBI bank stake with LIC:

LIC had a VNB margin of around 9.9% before listing, while private players had around 7.5% on average before listing, and now after several years after listing they grew their VNB beyond 20%. At the pre-IPO conference, LIC Chairman Kumar said he is confident of quickly catching up with private players on the profitability front and expects its VNB margins to cross 20% levels in coming years. This will be achieved at a pace faster than its private peers.

At present, the average VNB margin of the top five private LI players is around 25%. In FY21, LIC had a VNB of Rs.4.167B with a VNB margin of 9.9%, while HDFC Life had a VNB of Rs.2.185B with a VNB margin of 26.10%. SBI Life had a VNB of Rs.2.384B with a margin of 20.40% and ICICI Prudential at Rs.1.621B VNB with a margin of 25.10%.

LIC Chair Kumar pointed out:

“Investors should look at VNB margins and this is what they will be looking at. We are now at a VNB margin of 9.9 percent before listing. The rest of the industry was only at 6, 7, or 9 percent. Post listing, they grew their VNB to beyond 20 percent. How long did they take to reach 20? It will take much lesser time to reach that 20. I am on a much larger base--- I am not saying we will immediately go up to 40, but in a year or two, we will reach 12-13. Soon enough, and faster than them---

Private players who are now doing well were like small children who went to school, learned the alphabet, and have grown up. We are already a 65-year-old company, and now you are telling us to go to school. So I am starting there. But I already have a legacy and will work at a much faster pace in our post-listing journey—“

On LIC’s relevance and connection to millennials, Kumar said that LIC has been taking steps to engage more with millennials and has been upping its digital presence in recent years: “As many as 42 percent of our agents (1.3 million) are millennials, and in the last two years, 80 percent of those who joined are millennials. We have a ‘phygital’ model. India still wants to talk to somebody before going in to buy a life insurance product”.

In IDBI Bank, LIC has initially 51%, but after a QIP, LIC’s stake came below the 49% threshold of management control. However, LIC retains management control as the Indian government has about 45% stake in IDBI Bank. Now the government wants to disinvest IDBI bank to a private entity.

On IDBI bank stake, Kumar said LIC will divest its stake in IDBI Bank along with the government, but there is no clarity yet on what the quantum of stake sale would be. If the government were to permit it, then LIC would prefer to hold a small stake in IDBI Bank just as it has similar small stakes in several banks:

“I can’t put a number on how much I will look to shed. It all depends on the government and how the final transaction plays out and what kind of investor comes in. My stand is predicated on what the government will do. If the government were to exit, we would look to go along with the government or, if permitted, we would like to stick on to some holdings since we already have a stake in so many banks and continue our Banca partnership with IDBI Bank---

I don’t mind IDBI Bank remaining as a bancassurance partner... it is a win-win situation. Three years back, they were not even a Banca partner. For decades, we had so many Banca partners. Within three years, they (IDBI Bank) have become number one--- Going forward, LIC will focus its energies on growing its bancassurance and digital channels---

There is also an issue with EV (Embedded Value) calculation with LICI as the company didn’t provide any figure till the Q4FY22 report card. But now after pressure from the analyst community/market, LIC is now in the process of EV calculation and may soon disclose the same publicly.

As life insurance is a long-term business where one purchases a policy currently and continues to pay premiums for several years. It is from this future premium that the insurers make more profits. So the value of a life insurance company is assessed by future profits/premiums that the current business can generate. This is captured by the embedded value (EV) that represents the sum of the present value of all future profits from the existing business and shareholders’ net worth. As of 15^th Dec’21, listed private LI players such as HDFC Life, SBI Life and ICICI Pru have Price/EV multiple around 5.46, 3.81, and 3.16. It now seems that the market is giving a Price/EV multiple of around 0.75 to LICI as VNB is only around 1-1.50% of its overall policy in force.

As per LIC’s DRHP, the EV was around 0.96T as of 31^st Mar’21 and Rs.5.40T as of 30^th Sep’21, an abnormal jump just ahead of the IPO, which created a huge controversy over the treatment of equity book. Moreover, LICI didn’t disclose any EV as of 31^st March’22. Even the Federal Government intervened and asked LIC to compute correctly and disclose the same ASAP. Accordingly, LIC may disclose the FY22 EV by 30^th June’22.

LIC Chair Kumar said: “It is a long exercise (determination of Indian EV). We are implementing a new IT solution for the calculation of Indian embedded value and we need to cross-check all the data--- for the quarter ended September 30, 2021, and December 31, 2021, the corporation has checked all data and the output of the new system with the existing system and has found consistency in the numbers--It wants to cross-check the data for the period ended March 31, 2022, to ensure that the new IT system is perfect----

We have 285 products that need to be modeled into a new system. We have to check the consistency of the output for each of the products, and it is taking time. We don't want to rush into any number which can be questioned tomorrow. We want to be sure and hence we are taking a little more time---Going forward, from Q1 (FY23) onwards, it will not be taking so much time and we will be doing it (determining IEV) simultaneously along with the completion of the financial results----LIC will calculate Indian EV every quarter but has decided to declare the number on a half-yearly basis, a trend followed by the other industry players”.

As of 31^st Mar’2021, LIC’s persistency ratio for individual products (by total premium) was around 79% for the 13^th Month against 87.1% of the top five private peers on an average. For the 61^st month, the persistency ratio for LIC was around 59.0% against 54.4% for top private LI companies. Overall, LIC’s persistency ratio keeps dropping on the 25^th, 37^th, 49^th, and 67^th months intervals; i.e. significant policyholders are opting to discontinue their policies for the longer term, once they get surrender value equivalent to premiums paid. But the overall story remains almost the same for private players after the 61^st month as most of the agents/sales personnel encourage their clients to surrender policies after 5 years and buy a new policy which fetch them attractive initial commissions.

LIC has also muted VNB compared to other top three private players. Also, the VNB margin of LIC was around 9.3% compared to HDFC Life’s 26.4% and SBI Life’s 21.8%. Apart from huge operating costs including an attractive agents commission structure, LIC has lower penetration for cost-effective digital and bancassurance channels, unlike its private peers.

Fair valuation of LICI:

If we look at the LICI IPO prospectus, it has declared a consolidated EPS of Rs.4.70 in FY21-adjusted with post-IPO equity capital of Rs.6.325B against the pre-IPO figure of Rs.0.10B (Rs.6325.00 cr. vs Rs.100.00 cr.). The average sector PE of the Life Insurance sector in India was around 100. In that sense, the IPO fair value should be around Rs.470.00 instead of Rs.949.00 (higher band). Also, it’s worth mentioning that the average PE of Life Insurance Companies in the U.S. stock market is around 15. In any way, although, the market is always supreme, there may be no justification for the sky-high valuation (PE) of Life Insurance Companies, considering the muted growth of earnings and future business prospects amid an economic slowdown.

For LIC, the problem is even bigger as is the unofficial ‘SWF’ (Sovereign Wealth Fund) of the nation; it owns a significant part of Indian listed shares with a very long-term outlook. The present turmoil in Dalal Street is also negative for the LICI portfolio (MTM loss) and earnings, although it may be temporary.

In any way, in FY22, LICI reported a core operating EPS of Rs.6.49 vs 12.65 in FY21. Assuming an average PE of 80, the fair valuation for FY22 may be around 519; i.e. LICI scrip may scale around 519 in the coming days. In FY22, core operating revenue (premium income and investment gains) was around Rs.7.24T against Rs.6.91T in FY21 (+4.76%), but core operating expenses were around Rs.7.20T vs Rs.6.83T (+5.38%). Higher operating expenses were due to a surge in COVID-related death claims and higher employee compensations.

Highlights of Q4FY22 report card of LICI:

In Q4FY22, LICI reported operating revenue of around Rs.2.12T vs 1.75T sequentially (+21.23%) and 1.90T yearly (+11.64%). But operating expenses was around Rs.2.10T vs 1.75T (+20.14%) and 1.83T (+14.67%). Subsequently, core operating EPS was Rs.2.97 vs -0.03 (+9030%) and 10.53 (-71.82%). FY22 as well as FY21 earnings report card was distorted by COVID-related abnormal death claims and employee compensation. As per the LICI IPO prospectus (DHRP), the insurer has paid COVID-related death benefits for around Rs.16.96T in FY19, Rs.17.34T in FY20, Rs.23.483T in FY21, and Rs.29.311T in 9MFY22 (Mar-Dec’22). Similarly, HDFC Life, SBI Life, and ICICI Pru also disclosed elevated COVID-related death claims in FY22 amid the devastating 2^nd wave. Overall, FY22 death claims for the life insurance industries may be almost 3-times more than FY21.

But looking ahead, COVID-related death claims in FY23 onwards should be minuscule as the pandemic has already turned into an endemic. At the same time, COVID-induced general public awareness and digitalization may help the industry including LICI. As per IRDAI data, the first-year premium of life insurers has grown by over +84% in Apr’22 to around Rs.17.940B from Rs.9.739B in Apr’21. Although there was a lower base effect, increasing public awareness about life insurance coverage after COVID played a great part in the growth story.

Fair valuation: LICI: Rs.1075-1857 by FY: 23-26

Thus, considering almost normal death claims and double-digit business growth, LICI’s core operating EPS may be around Rs.13.43 against 6.49 in FY22 and 12.65 in FY21. Further, considering normalized business growth around +20% CAGR in FY24-26 and assuming an average PE of 80, the fair valuation of LICI may be around 1075-1230-1548 and 1857 through FY24-26.

Eventually, a valuation of a company depends upon core operating EPS and PE multiples, which the market is willing to pay for the future potential of the company. PE depends upon lots of factors like earnings growth, industry/business nature, CF/FCF, balance sheet strength, and strategy of expansion/diversification.

In the case of LICI or private LI players, EV, VNB, or whatever may be the valuation narrative, considering sector PE of 100, valuations of all listed LI companies in India are very expensive compared to the average growth of core operating EPS. And have also very muted core operating margin (EBITDA/EBTDA margin).

As per the report, LIC’s retail premium collection is gaining traction in Q1FY23, and the growth rate of +32% (y/y) is higher than the overall sector, while also above 2019 (pre-COVID) levels. Looking ahead, although any significant economic slowdown may also affect the whole LI industry including LICI, overall, as the COVID disruption is over, we may see normalized growth in profitability.

LIC may also change its business strategy. As a pointer, participating (par) life insurance policy allows policyholders to participate in the profits of a life insurance company, while a non-participating (non-par) plan does not offer any dividend payouts. Looking ahead, LIC will focus only on non-par products for higher margins and VNB.

LICI Chair Kumar said:

“At present, the corporation's product mix is dominated by the participating business but going further its driver of growth will be a non-participating business. We have already decided that in future we will be launching only non-par products. With the product mix changing towards the non-par side in the future at a greater pace than the par side, the value of the new business (VNB) will be created. That is the strategy we are adopting.

LIC’s biggest driver of growth will be the bancassurance channel. It is having 72 tie-ups with different banks, which gives 60,000 outlets to sell its products. Over the next 5 years, it plans to activate each and every outlet available to it for selling products.”

On the Q4FY22 report card, Kumar said: “Earlier the profits were declared at the end of the year only. So that's why the quarterly numbers are not comparable. This year's (FY22) Q4 number is not comparable with Q4 of last year (FY21) because it was for the full year (FY21)--- from September 2022 onwards, the comparable data points will be available.”

P&L A/C analysis of LICI:

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