SELL (as at 30 April 2021)
• Net profit increased 67 percent year over year to CNY28.6 billion in 1Q21, led by stronger investment income, in line with the company’s recent profit expectations.
• NBV, on the other hand, declined 13% yoy in the fourth quarter, while agent headcount declined 7% to 1.282 million, underscoring the industry’s enduring troubles as a result of the epidemic.
• The fair value has been set at CNY30.20. China Life had an excellent comprehensive solvency ratio of 275 percent. The company acknowledged that Huarong bonds account for a small portion of its total assets, but the risk is manageable in the context of the broader portfolio. Thesis on Investment As a leading domestic life insurer, China Life is one of the primary beneficiaries of this medium-term growth trend, with expanding protection and wealth management needs of China’s increasing middle class.
The regulatory shift toward a more long-term and protection product mix is favorable for future margins, but the transition to the new business model and transformation process led by new management may be difficult given the current difficult operating environment, which is hampered by concerns about volatile equity markets and the impact on face-to-face sales recovery following the Covid-19 outbreak. As at the conclusion of FY20, the dividend distribution was 36 percent.
While we see long-term value, we believe investors will need to be patient given the sector’s continued gradual recovery outlook, as offline business takes time to normalize amid increased competition, and the stabilization of China’s bond yield and improved Ashare equity market on the back of a better macro backdrop should support investment income generation. Summary of Investments
• Net profit increased 67 percent year over year to CNY28.6 billion in 1Q21, meeting the company’s latest profit expectations and accounting for half of full-year consensus projections. Strong investment performance and fewer commission charges propelled the company forward in the first quarter. The fall in the 750-day average bond yield resulted in a reserve adjustment of CNY7.3 billion, which had a minor impact. The gross investment yield increased by 1.3 percentage points to 6.44 percent.
• Despite the outstanding 1Q bottom line, new business value (NBV) growth slowed 13 percent year over year last quarter (reflecting a larger base in 1Q20), while agent headcount declined 7% to 1.282 million. FYP (first year premiums) for regular premiums fell 10% year over year.
• Wary about near-term growth momentum, but nevertheless aiming for a stable year, with a continued focus on improving agent quality – On the near-term sales outlook, management was cautious, citing industry-wide concerns such as heightened competitive pressures, a slower recovery from the epidemic, and persistent difficulty in agent recruiting. We see this as being comparable to management’s end-of-fiscal-year statement, which mentioned a higher baseline for comparison and fierce competition. In 2021, efforts will continue to focus on agency quality, productivity, and retention (using various techniques such as recruitment thresholds, training, and so on), with profitability criteria accounting for roughly two-thirds of agency performance evaluation.
• Potential risk associated with Huarong exposure should be monitored, while key investor focus should remain on the industry’s NBV recovery speed. – While China Life’s comprehensive solvency ratio improved to 275 percent in the first quarter, the company revealed that it has a limited exposure to Huarong bonds that is manageable (no more information were offered) in the context of overall risk management. Furthermore, the firm has no stock exposure to Huarong (a state-owned financial institution that was recently revealed by Bloomberg to have received cash from a state-owned bank to repay an offshore bond, after the government’s request for a loan extension). Huarong shares are held by China Life Group (not the listed entity), which owns 4.22 percent of the company. Non-bank financial enterprises accounted for 2.4 percent of the listed company’s total assets, according to its FY20 statistics, implying that Huarong exposure is likely to be small, but it’s still worth keeping an eye on.
• Based on sum of parts valuation, fair value is modified to CNY30.20, representing the greater historical traded valuation range for the A-share (restricted free float), which suggests 1.9x p/b, close to -1 standard deviation from its historical average 10Y valuation range.
catalysts for change
• New business value growth that is more robust. Lower reserve charges could result from higher bond returns, boosting life profits and group earnings. A surge in the stock market could result in greater valuations and investment gains. Better management execution and improved disclosure on the back book. The payment of dividends is linked to a more stable growth indicator (e.g. operating profit). More transparency and clarity on asset/liability management are needed (i.e. viewed to be more relatively exposed to interest rate risks vs peers, historically has a more volatile net profit track record). Performance goals that are more market-oriented.
Investing dangers
• Sharp A-share equity market corrections and falling interest rates, macroeconomic deterioration, regulatory/policy risks, competitive pressures, interest rate concerns, illness outbreaks, profits and NBV disappointments Earnings will be hampered by lower bond yields. Due to capital market volatility, profitability may remain volatile. The lack of absolute NBV disclosure and guidance on full-year NBV increase has made measuring the sustainability of improvements difficult. Problems about asset/liability matching and credit concerns in the company’s investment portfolio. Margins are being impacted by the launch of drastically discounted products.
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