Investment Shastra

HDFC Life IPO : Higher share of traditional policies but stretched valuations

Issue Date: Nov 7, 2017 – Nov 9, 2017

Face Value: Rs 10 Per Equity Share

Issue Type: Book Built Issue IPO

Issue Size: (Rs Crore) 8245-8695

Price Band: Rs 275 – Rs 290 per equity share

No of Shares on Offer: 29.9 crore (QIB 50%, Non-Institutional 15%, Retail 35%)

Market Lot: 50 Shares

Minimum Order Quantity: 50 Shares

Listing At: BSE, NSE

About the company

HDFC Standard Life Insurance Company Ltd (HDFC Life), incorporated in 2000, is Mumbai based life insurance provider. It is a joint venture between HDFC and Standard Life Aberdeen plc. It offers a wide range of individual and group insurance solutions including Protection, Pension, Savings & Investment and Health, along with Children’s and Women’s Plan. As on Sept 2017, its product portfolio comprised of 32 individual and 10 group products as well as 8 optional rider benefits. It sells policies through its own branches, Insurance agents, Partner Banks and through other financial institutions.

  • With a total AUM of Rs 9953 Cr as of September 2017, HDFC Life is India’s third largest private life insurance provider, after SBI Life and ICICI Prudential. It has an Indian Embedded Value of Rs 14010 Cr.
  • Its annualized premium equivalent grew by a CAGR of 14.5% from FY15 to FY17. HDFC Life’s focus on creating a multi-channel distribution platform has resulted in increased market share in terms of total new business premium from 15.8% in FY15 to 17.2% in FY17
  • It also had a strong solvency ratio of 201% above the minimum 150% solvency ratio by IRDAI regulations. Its individual persistency ratio stood at 73.3% (FY15), 78.9% (FY16), 80.9% (FY17) and 82.2% (Sept 2017).
  • In terms of distribution strength, it has 66,372 individual agents (which comprise 6.8% of all private agents in the Indian life insurance industry) and has 125 banking tie-ups including HDFC Bank giving access to the huge branch network.

MoneyWorks4me opinion:

HDFC Life’s new business premium or NBP has recorded phenomenal growth due to the direct business from its expanding branch network. It grew at a 5 year CAGR (FY12-FY17) of 17.8%, higher than ~9% CAGR growth clocked by other leading peers such as SBI Life and ICICI Prudential Life. However both SBI Life and ICICI Pru Life were affected by the regulatory changes in FY13-FY14. Hence, the right period to assess the growth trend of insurers would be the past 3 years (FY15-FY17). On that front also, HDFC Life has recorded higher growth of 25.8% in new business premium leading to market share growth. Its margin on the value of new business (VNB margin) was 22 per cent in FY17 compared with 10-19 per cent for peers.

HDFC Life has a healthy balance sheet with total net worth of Rs 4460 Cr and solvency ratio of 200.5% as at September 30, 2017, above the minimum 150%. Both, total income and PAT doubled in in the past four year (FY13-FY17) to Rs 30,554.4 Cr and Rs 886.9 Cr.

We also like the quality of HDFC Life’s portfolio, as 53% of the portfolio consists of traditional policies like term insurance and annuities. As compared to this ICICI Pru Life has almost 74% share of market-linked products like ULIPs. Traditional policies also form 26% of HDFC Life’s NBP as compared to only 5% for SBI and ICICI.

A higher share of traditional policies works in HDFC Life’s favour as it reduces exposure to market volatility. However, a large part of the recent growth in insurance premiums for all insurers has come from selling of ULIP like products (74% of HDFC Life’s NBP still comes from these products), which tend to sell when equity markets are doing great. Currently, investors are attracted ti these products due to the high returns provided by equity and debt markets. On the other hand, other assets like real estate and gold are being side-lined due to their lower returns as compared to equity. We believe that these market linked products will fall out of favour when equity markets are not doing so well, thus reducing the growth of NBP for life insurers.

The one thing that does not work in HDFC Life’s favour is its steep valuations.

Price to Embedded Value (P/EV) is the right metric to value life insurance companies, as it captures the long-term profitability of the existing business. At the upper end of the IPO price band of Rs 275-290, the stock is available at P/EV multiple of 4.2x at current embedded value of 14010 crore. As compared to this SBI Life and ICICI Prudential Life are trading at 3.6x and 3.3x P/EV multiples, respectively. A look at the above table also tells us that the IPO is expensive based on both PE and PBV multiples.

We believe life insurance companies are fairly valued at 1.5-2X future embedded value multiple, as cross cyclical ROEs can’t exceed 15-18%. This implies a 20-25% growth in premium over the next five years, which we think is extremely difficult.

We are also of the opinion that it is unjustified to pay higher valuation for a life insurer with lower total share of premiums and lower profitability as compared to peers (see table above).

Thus, we recommend investors to avoid the IPO on stretched valuations.

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