Key lessons:
– Do the work when not in a rush and be ready to buy in
– When you finally invest, do it with conviction and take a significant position
– Then, be patient
Towards the end of 2015, while I was studying for the Hong Kong part of my MBA at The University of Hong Kong, I started to get interested in the insurance industry and particularly insurance companies with a strong exposure to China. Considering the historical growth and potential of the industry in China, I had to have a more in-depth look at these fascinating financial companies. Growth is certainly a key word here. As a side note, I was in mainland China just yesterday where I visited Guangzhou (located about two hours by train from Hong Kong), which ended up being a failed attempt at finding good deals on furniture… However, I was amazed at the growth and progress of this city compared to when I studied Mandarin over there for a few months about 7 years ago. The exciting part is that when visiting cities such as Guangzhou you realize how much more there is to be done and the huge underlying potential still to be exploited.
Back to insurance, I am not a macro type of investor, but in this case there are a few metrics which we need to have a look at. To keep it simple, let’s have a look at two main data sets for China: 1) Premium growth and 2) Penetration rate as a percentage of GDP, compared to other major markets. In terms of growth, in 2016 China led the pack by a huge margin and accounted for almost half the global growth. The growth of written premiums in China grew at about 23% in 2016, which is way ahead of Eastern Europe with less than 11%.
Considering penetration rates as a percentage of GDP, we can see how much additional potential there is still left in China. China’s penetration rate is certainly going up, but it’s far from the levels reached by other developed markets. Compared to Hong Kong and Taiwan, the difference is even more noticeable. These two neighbouring regions top the international league tables with penetration rates in the high teens.
China Insurance Penetration Rates
The macro trends are certainly present in China to support the growth of the insurance industry, which is expected to grow much faster than the overall economy. But then the question becomes which company should I put my money on?
So, in the last quarter of 2015, I started looking at the different players with substantial activities in mainland China and quickly narrowed down my research to two major players: Ping An Insurance (2318.HK) and AIA Group (1299.HK). They are both very strong insurance companies, but for different reasons. As I was looking to select one of the two, I had to make a choice. However, in retrospect, I could have invested in both without any problem (so far…). Although AIA has a very strong management and a proven track record, its historical growth at the time was lower than Ping An’s growth and it has a much lower exposure to mainland China as it generates most of its revenue from Hong Kong and other Asian countries, 45% and 43% of Annualised New Premiums during FY2016, respectively. In addition, AIA Group was – and still is – a more “expensive” stock to buy based on several valuation metrics and methodologies. At the end, I chose to invest in Ping An Insurance and hopefully the reasons behind my choice will become clear in the next few paragraphs.
Ping An was founded in 1988 and listed on the Hong Kong Stock Exchange in 2004. It currently ranks 39th in Fortune’s Global 500, remaining the top ranked Chinese insurer. It is number two as to life insurance market share, after China Life, and currently is the most valuable Chinese insurance company in terms of market cap (HK$1.13 trillion). When considering different targets within the industry, I quickly realized that I had to focus on the major players. As a customer (always consider the customer’s perspective!), when looking for insurance coverage you want to make sure that the provider has a strong track record and is going to be around for a while and smaller players in China seemed to suffer both in terms of growth and profitability. The last thing you want is for your insurance company to end up in the press just like Anbang did recently, causing a lot of instability. Although insurance represents Ping An’s largest segment, it is important to note that the company is also active in other areas such as banking and asset management. The firm’s objective is “to become a world-leading personal finance services provider”. As we will see, this diversification is and will play an important role in the firm’s strategy going forward.
To give you a quick idea, below are summary financial figures for FY2016 and previous years.
5-year summary – impressive growth!
Source: Company
Business segmentation
Source: Company
For the first half of 2017, the company’s results are even better and the growth of the business has literally exploded, together with a sustained level of ROE. Embedded value is up about 16%, value of new business is up over 46%, net profit is up by 6.5% and operating metrics such as number of internet users, number of individual customers, and number of contracts per customer are all up substantially. Profit per customer went up from RMB 203.97 to RMB 241.66, an increase of 18.5%. Metrics per insurance agent, which are very important, also improved. For example, agents’ per capita income per month grew by 14% year on year. What’s even more interesting is how Ping An can still achieve tremendous growth given its huge size. The insurance industry is a data heavy industry and so it would be easy to spend 50 pages analysing the different financial and operating metrics, but I’ll let you do your own homework, if interested. In addition to gaining knowledge, whenever analysing a company, doing your own work will also provide you with the necessary conviction that you’ve done the right thing and allocated your capital wisely when times (might) get tough.
So, back to the end of 2015, I was putting some work into understanding Ping An better, but I wasn’t in any kind of rush. However, little did I know that in January 2016 the stock price would tank and give me just the right opportunity to buy in with a comfortable margin of safety. I was then able to take a large position (relative to my portfolio) at an entry price of approximately HK$35 per share. At that price, I just couldn’t comprehend why the market would value the company at such a low price given its recent historical performance and the prospects of the firm. As it is often the case, Mr. Market wasn’t being rational. In addition, I knew this was the kind of company I could buy and hold for a very, very long period of time. So, I wasn’t in a hurry to make a quick buck. It took some time, but it eventually paid off. The stock price as of last Friday stood at $61.60, which represents a gain of 76% in about 20 months… not bad!
As mentioned, Ping An is not only active in the insurance industry but also in banking, asset management, and others. Taking a step back and with better perspective, it seems that the market was discounting the stock price of the company because of its diversified offering of financial services. The model of a diversified financial services conglomerate has previously been tested in the West and mostly failed. However, today is a different story and Ping An hopes to leverage on technology to develop its platform and believes that the network effect will push business even further. This is the main reason why the company has put so much emphasis on fintech lately. In a market so attuned to technology such as China, this could potentially work out very well for them. If their efforts pay off, they will be able not only to benefit from increasing market demand but to do better than their peers by delivering financial services in an innovative and efficient way. Even if not an astounding success, with such a strong place in the market, Ping An should be able to deliver without too much problem – as long as they keep their financials in line. As a company mainly active in the insurance industry, they can’t compromise on their financial position.
The next question is: what should I do with my investment now? Some people argue that at the current share price, the price-to-book multiple of Ping An of 2.3x is too high. Well, I agree that it’s not a deep-value opportunity and yes it is a bit more expensive than it was a few weeks ago. However, you always have to update your analysis of a company based on the latest facts available and from what I have observed and my calculations, this company doesn’t seem to be overpriced – even if there is limited growth in the future, which doesn’t seem to be the case either. This is the kind of good company that you want to hold for the long term, unless of course if something fundamental goes wrong. So, for now, I’m happy with my position and will keep a close eye on the firm and the behaviour of Mr. Market, which might offer some interesting discounts in the future and an opportunity to buy more of the good stuff!
