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Max India (MAXI.BO, Buy (Conv. List)): Maximising the turnaround
Source of opportunity
We are initiating coverage on Max India, a conglomerate with business
interests in life insurance, healthcare and health insurance, with a Buy
rating (adding it to the Conviction List) and 12-month target price of
Rs190, indicating potential upside of 30%. We see three potential drivers
of stock outperformance: (1) significant correction in valuations (>60%
relative underperformance to Sensex), while operating performance has
been improving; (2) life and health care businesses turning around, will
make a profit on cost cuts, higher utilizations; and (3) capital requirement
for life tapering, though this will remain high for healthcare and health
insurance – but the extent will be lower than in the past. Additionally,
the company is sitting on cash of Rs5.8bn which will be more than
sufficient to meet these capital requirements.
Catalyst
We expect the company to deliver profit from here on in the: (1) life
insurance business of Rs1.9bn in FY11E and Rs4.4bn in FY12E vs. losses
reported in earlier years; and (2) health care business to report EBIT of
Rs217mn in FY12 vs. a loss of Rs177mn in FY10 on higher occupancy in
their hospitals and cost rationalisation.
Valuation
Our SOTP-based 12-month target price of Rs190 is arrived at using:
(1) for the insurance business, the appraisal value method (assumes EV
+ structural value, NBV margin of 12% and multiple of 14X); (2) DCF for
the health care business; and (3) health insurance at book value.
Key risks
Incremental focus on traditional products, which could be the next
product to be targeted by the regulator; lower persistency than expected
thereby impacting margins; and capital markets dependency as it drives
volume growth.
Max India: A proxy for the Indian insurance sector
We are initiating coverage on Max India, a conglomerate with business interests in life
insurance, healthcare and health insurance, with a Buy rating (adding it to the Conviction
List) and target price of Rs190, indicating potential upside of 30%. The company has been
underperforming the market over the last two years first on back of global financial crises
which led to huge decline in stock markets and then on concerns of new regulatory
changes and their impact on volumes and margins for the company. We see three key
reasons the stock may outperform: (1) significant correction in valuations, while operating
performance has been improving; (2) life and health care businesses turning around, will
make a profit on cost cuts, higher utilizations; and (3) capital requirement for life tapering,
though this will remain high for healthcare and health insurance – but to a lesser extent
than in the past. Additionally, the company is sitting of cash of Rs5.8bn which will be
more than sufficient to meet these capital requirements. We use appraisal value method
to value the life insurance business and DCF for the health care business. We have
assumed 12% NBAP margins and flat APE growth in FY12E.
Key risks: (1) change in regulations, specifically on traditional products (which have been
untouched by regulators so far); (2) long-term we believe the ULIP market will prevail,
given that India is a savings markets, as traditional products provide lower net returns vs.
ULIPs given restriction on investment in equities. Max may do well in the near term but
may have to consider changing its product mix to at least 50:50 from 70% traditional and
30% ULIPs currently.
Consolidated profits and RoE to rise
We expect Max India’s consolidated profit to rise to Rs2.18 bn in FY12E from a loss of
Rs757mn in FY10. We expect the life insurance and healthcare businesses to turn around
and add to its profits and RoE. Additionally, Max India currently has sufficient cash to meet
the funding requirements of both the healthcare and the health insurance businesses. The
company is sitting on a treasury corpus of Rs5.8bn, whereas our estimated requirement for
health insurance and health care is Rs5.9bn over the next three years. The company’s
consolidated borrowings are Rs.4.5bn which includes Rs3.8bn in Max Healthcare and
Rs0.6bn in speciality films.
Max New York Life: Re-aligning its strategy
Max New York Life (MNYL) contributed 60% of Max India’s FY10 consolidated
revenues. Like other Indian life insurers, to protect volume growth and margins,
the company has changed its strategy: (1) it is now increasing its proportion of
traditional products to two-thirds of premiums vs. unit-linked products
dominating premium share at 70% in FY10; and (2) reducing costs and improving
productivity. We use the appraisal value method (assuming 12% NBAP margins
and 14X NBAP multiple) to value this business. The insurance business adds
accounts for around 90% of the overall SOTP of Max India.
Traditional product bias from here on
As of FY10, unit-linked products contributed about 70% of MNYL’s premium and 72% of
policyholder AUM. However, around 85% of new business in 3QFY11 was contributed by
traditional products. Going forward, the company intends to focus on traditional policies, with
this accounting for two-thirds of the overall business. The traditional products market in India is
predominantly a with profits (participating – companies in India are required to share 90% of
the profit on policies with the policyholder) market, which used to be less profitable than ULIP
products as 90% of the surplus is distributed to policyholders. The persistency ratio in this
product is high at >80% and surrender ratio low, as seen in Max’s historical numbers. The key
competitor for MNYL in traditional products is LIC, which has a strong foothold in Tier-II and III
cities. We are expecting MNYL to deliver 9% growth in new premium income in FY11E, 4.3% in
FY12E and 17.1% in FY13E.
Focus on reducing costs
MNYL has focused on reducing costs in the context of industry headwinds. As of 9MFY11,
MNYL’s cost ratio was down 380bp to 27.2% in 9MFY11, a function of multiple initiatives.
The company trimmed its agency force by 16.8% since March 2010 to 54,699 with
unproductive agents being weeded out, and reduced employee headcount by 25% to 8,698.
The company has indicated cost ratios will trend down to 18% by FY12E with plans to
further bring it down to 14% eventually. Given the competitive environment we have not
factored this in our estimates and instead project a cost ratio of 24.5% for FY12E,
preferring to be reactive to better execution given the sensitivities/risks involved.
Axis Bank tie-up: required dimension to distribution franchise
In May 2010, MNYL entered into a 10-year agreement with Axis Bank (India’s third largest
private sector bank with 1,100+ branches) to distribute its insurance products. This
arrangement helps MNYL expand its reach, while also reducing dependence on the agency
channel which until March 2010 contributed 70% of new business premiums. As at
9MFY11, the contribution of banking channel had quadrupled over FY10 levels to 17%, or
around Rs2.4bn (3QFY11: Rs1.2bn). Incrementally, Axis Bank is sourcing 25% of new
business premiums for MNYL, of which 90% is traditional business. The strength of the
distribution agreement is fortified by a 4% stake bought by Axis Bank in MNYL around the
same time, thereby better aligning each party’s interests.
Valuations – insurance to contribute 90% of Max’s value
We think MNYL is the closest listed proxy to India’s structural insurance story. We believe
most of the negatives have been priced in, with the market expecting lower margins and
volumes. The industry – once in the limelight – has lost its charm for investors and we
believe it is time for a relook, with Max providing the maximum leverage to this business.
While volume growth may still lag, we believe that companies will start showing profits,
which along with falling cost ratios and improving persistency could provide the inflexion
point for this industry.
We use the appraisal value method (Embedded value + Structural value, margin of 12%
and 14X multiple) to arrive at our implied value estimate for this business. Our margin
estimate is below the company’s guidance of 13% to 14%, which management indicated
could improve further if persistency ratios improve. Max also indicated it had assumed a
prudent approach to persistency (70% on 13-month persistency for traditional business
and 75% for ULIP business vs 67%-68% currently) and a sensitivity of 8% to 10%
improvement in persistency would translate into NBAP margin of 18%-19%. We have
valued Max India’s stake in MNYL at Rs174/share (92% of target price).
Max BUPA Health insurance: At a nascent stage
Max BUPA Health insurance (MBHI) is a joint venture with the UK’s BUPA to provide health
insurance in India’s under-penetrated market. The JV partners have infused Rs2.7bn of
capital so far and estimate peak commitment of Rs7bn. Max India owns a 74% stake in the
company and Bupa 26%. Currently, the company is establishing the distribution
infrastructure (in-house vs. reliance on third parties), streamlining processes and systems,
and tying up with hospitals (targeting 500 big ones).
The health insurance business has not proved to be profitable for other life insurers/nonlife
insurers in India due to high claims, including fraudulent cases. However, the company
believes there are likely synergistic benefits given the Group’s presence in the healthcare
business (it owns four hospitals). While it is still early days, the company estimates it will
break even in four to five years. We estimate the company will report losses of Rs1.2bn in
FY12 and Rs1.7bn in FY13.
Given the nascent stage of this business, we have valued it at 1X capital invested, or
Rs5/share (3% of target price).
Max Healthcare: A defensive business in the hospitals space
Max Healthcare (MHC) is a leading provider of healthcare services operating eight centres
in Delhi and the National Capital Region (NCR) region. MHC will be increasing its footprint
in North India with the launch of super speciality hospitals in Dehradun and 2 PPP projects
in Punjab (Mohali and Bathinda) with capacities of 300 beds each. MHC has a registered
patient base of 1.1mn patients, with almost 250,000 patient footfalls every month.
We expect a steady 16% revenue CAGR over FY11E-FY13E on the back of:
Expansion in footprint and the proposed doubling of its bed capacity to 2000 beds by
FY12E, which management guides is on track for completion.
As more of their hospitals enter the mature phase, the revenue share from drugs
should increase from 21% as of FY10 to 27% in FY13E.
MHC has achieved a cash breakeven this quarter and it has been led by a sequential
growth and improvement in its EBITDA margins (100bps improvement in the period ending
9MFY11). As their occupancy rates improve, coupled with higher revenue per bed (Current
average occupancy at their hospitals is at c. 68.2% with average length of stay at being 3.5
days), we expect MHC to break even on EBIT/net income in FY11 and generate Rs415mn in
EBIT by FY13E.
We value Max Healthcare on a DCF valuation methodology as it continues to invest in
growth, and arrive at a value of Rs8/share.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Max India (MAXI.BO, Buy (Conv. List)): Maximising the turnaround
Source of opportunity
We are initiating coverage on Max India, a conglomerate with business
interests in life insurance, healthcare and health insurance, with a Buy
rating (adding it to the Conviction List) and 12-month target price of
Rs190, indicating potential upside of 30%. We see three potential drivers
of stock outperformance: (1) significant correction in valuations (>60%
relative underperformance to Sensex), while operating performance has
been improving; (2) life and health care businesses turning around, will
make a profit on cost cuts, higher utilizations; and (3) capital requirement
for life tapering, though this will remain high for healthcare and health
insurance – but the extent will be lower than in the past. Additionally,
the company is sitting on cash of Rs5.8bn which will be more than
sufficient to meet these capital requirements.
Catalyst
We expect the company to deliver profit from here on in the: (1) life
insurance business of Rs1.9bn in FY11E and Rs4.4bn in FY12E vs. losses
reported in earlier years; and (2) health care business to report EBIT of
Rs217mn in FY12 vs. a loss of Rs177mn in FY10 on higher occupancy in
their hospitals and cost rationalisation.
Valuation
Our SOTP-based 12-month target price of Rs190 is arrived at using:
(1) for the insurance business, the appraisal value method (assumes EV
+ structural value, NBV margin of 12% and multiple of 14X); (2) DCF for
the health care business; and (3) health insurance at book value.
Key risks
Incremental focus on traditional products, which could be the next
product to be targeted by the regulator; lower persistency than expected
thereby impacting margins; and capital markets dependency as it drives
volume growth.
Max India: A proxy for the Indian insurance sector
We are initiating coverage on Max India, a conglomerate with business interests in life
insurance, healthcare and health insurance, with a Buy rating (adding it to the Conviction
List) and target price of Rs190, indicating potential upside of 30%. The company has been
underperforming the market over the last two years first on back of global financial crises
which led to huge decline in stock markets and then on concerns of new regulatory
changes and their impact on volumes and margins for the company. We see three key
reasons the stock may outperform: (1) significant correction in valuations, while operating
performance has been improving; (2) life and health care businesses turning around, will
make a profit on cost cuts, higher utilizations; and (3) capital requirement for life tapering,
though this will remain high for healthcare and health insurance – but to a lesser extent
than in the past. Additionally, the company is sitting of cash of Rs5.8bn which will be
more than sufficient to meet these capital requirements. We use appraisal value method
to value the life insurance business and DCF for the health care business. We have
assumed 12% NBAP margins and flat APE growth in FY12E.
Key risks: (1) change in regulations, specifically on traditional products (which have been
untouched by regulators so far); (2) long-term we believe the ULIP market will prevail,
given that India is a savings markets, as traditional products provide lower net returns vs.
ULIPs given restriction on investment in equities. Max may do well in the near term but
may have to consider changing its product mix to at least 50:50 from 70% traditional and
30% ULIPs currently.
Consolidated profits and RoE to rise
We expect Max India’s consolidated profit to rise to Rs2.18 bn in FY12E from a loss of
Rs757mn in FY10. We expect the life insurance and healthcare businesses to turn around
and add to its profits and RoE. Additionally, Max India currently has sufficient cash to meet
the funding requirements of both the healthcare and the health insurance businesses. The
company is sitting on a treasury corpus of Rs5.8bn, whereas our estimated requirement for
health insurance and health care is Rs5.9bn over the next three years. The company’s
consolidated borrowings are Rs.4.5bn which includes Rs3.8bn in Max Healthcare and
Rs0.6bn in speciality films.
Max New York Life: Re-aligning its strategy
Max New York Life (MNYL) contributed 60% of Max India’s FY10 consolidated
revenues. Like other Indian life insurers, to protect volume growth and margins,
the company has changed its strategy: (1) it is now increasing its proportion of
traditional products to two-thirds of premiums vs. unit-linked products
dominating premium share at 70% in FY10; and (2) reducing costs and improving
productivity. We use the appraisal value method (assuming 12% NBAP margins
and 14X NBAP multiple) to value this business. The insurance business adds
accounts for around 90% of the overall SOTP of Max India.
Traditional product bias from here on
As of FY10, unit-linked products contributed about 70% of MNYL’s premium and 72% of
policyholder AUM. However, around 85% of new business in 3QFY11 was contributed by
traditional products. Going forward, the company intends to focus on traditional policies, with
this accounting for two-thirds of the overall business. The traditional products market in India is
predominantly a with profits (participating – companies in India are required to share 90% of
the profit on policies with the policyholder) market, which used to be less profitable than ULIP
products as 90% of the surplus is distributed to policyholders. The persistency ratio in this
product is high at >80% and surrender ratio low, as seen in Max’s historical numbers. The key
competitor for MNYL in traditional products is LIC, which has a strong foothold in Tier-II and III
cities. We are expecting MNYL to deliver 9% growth in new premium income in FY11E, 4.3% in
FY12E and 17.1% in FY13E.
Focus on reducing costs
MNYL has focused on reducing costs in the context of industry headwinds. As of 9MFY11,
MNYL’s cost ratio was down 380bp to 27.2% in 9MFY11, a function of multiple initiatives.
The company trimmed its agency force by 16.8% since March 2010 to 54,699 with
unproductive agents being weeded out, and reduced employee headcount by 25% to 8,698.
The company has indicated cost ratios will trend down to 18% by FY12E with plans to
further bring it down to 14% eventually. Given the competitive environment we have not
factored this in our estimates and instead project a cost ratio of 24.5% for FY12E,
preferring to be reactive to better execution given the sensitivities/risks involved.
Axis Bank tie-up: required dimension to distribution franchise
In May 2010, MNYL entered into a 10-year agreement with Axis Bank (India’s third largest
private sector bank with 1,100+ branches) to distribute its insurance products. This
arrangement helps MNYL expand its reach, while also reducing dependence on the agency
channel which until March 2010 contributed 70% of new business premiums. As at
9MFY11, the contribution of banking channel had quadrupled over FY10 levels to 17%, or
around Rs2.4bn (3QFY11: Rs1.2bn). Incrementally, Axis Bank is sourcing 25% of new
business premiums for MNYL, of which 90% is traditional business. The strength of the
distribution agreement is fortified by a 4% stake bought by Axis Bank in MNYL around the
same time, thereby better aligning each party’s interests.
Valuations – insurance to contribute 90% of Max’s value
We think MNYL is the closest listed proxy to India’s structural insurance story. We believe
most of the negatives have been priced in, with the market expecting lower margins and
volumes. The industry – once in the limelight – has lost its charm for investors and we
believe it is time for a relook, with Max providing the maximum leverage to this business.
While volume growth may still lag, we believe that companies will start showing profits,
which along with falling cost ratios and improving persistency could provide the inflexion
point for this industry.
We use the appraisal value method (Embedded value + Structural value, margin of 12%
and 14X multiple) to arrive at our implied value estimate for this business. Our margin
estimate is below the company’s guidance of 13% to 14%, which management indicated
could improve further if persistency ratios improve. Max also indicated it had assumed a
prudent approach to persistency (70% on 13-month persistency for traditional business
and 75% for ULIP business vs 67%-68% currently) and a sensitivity of 8% to 10%
improvement in persistency would translate into NBAP margin of 18%-19%. We have
valued Max India’s stake in MNYL at Rs174/share (92% of target price).
Max BUPA Health insurance: At a nascent stage
Max BUPA Health insurance (MBHI) is a joint venture with the UK’s BUPA to provide health
insurance in India’s under-penetrated market. The JV partners have infused Rs2.7bn of
capital so far and estimate peak commitment of Rs7bn. Max India owns a 74% stake in the
company and Bupa 26%. Currently, the company is establishing the distribution
infrastructure (in-house vs. reliance on third parties), streamlining processes and systems,
and tying up with hospitals (targeting 500 big ones).
The health insurance business has not proved to be profitable for other life insurers/nonlife
insurers in India due to high claims, including fraudulent cases. However, the company
believes there are likely synergistic benefits given the Group’s presence in the healthcare
business (it owns four hospitals). While it is still early days, the company estimates it will
break even in four to five years. We estimate the company will report losses of Rs1.2bn in
FY12 and Rs1.7bn in FY13.
Given the nascent stage of this business, we have valued it at 1X capital invested, or
Rs5/share (3% of target price).
Max Healthcare: A defensive business in the hospitals space
Max Healthcare (MHC) is a leading provider of healthcare services operating eight centres
in Delhi and the National Capital Region (NCR) region. MHC will be increasing its footprint
in North India with the launch of super speciality hospitals in Dehradun and 2 PPP projects
in Punjab (Mohali and Bathinda) with capacities of 300 beds each. MHC has a registered
patient base of 1.1mn patients, with almost 250,000 patient footfalls every month.
We expect a steady 16% revenue CAGR over FY11E-FY13E on the back of:
Expansion in footprint and the proposed doubling of its bed capacity to 2000 beds by
FY12E, which management guides is on track for completion.
As more of their hospitals enter the mature phase, the revenue share from drugs
should increase from 21% as of FY10 to 27% in FY13E.
MHC has achieved a cash breakeven this quarter and it has been led by a sequential
growth and improvement in its EBITDA margins (100bps improvement in the period ending
9MFY11). As their occupancy rates improve, coupled with higher revenue per bed (Current
average occupancy at their hospitals is at c. 68.2% with average length of stay at being 3.5
days), we expect MHC to break even on EBIT/net income in FY11 and generate Rs415mn in
EBIT by FY13E.
We value Max Healthcare on a DCF valuation methodology as it continues to invest in
growth, and arrive at a value of Rs8/share.
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