Macquarie downgrades 3 private sector insurers on growth concerns

Brokerage firm Macquarie has downgraded the ratings of three leading private sector insurers HDFC Life, ICICI Prudential Life and SBI Life from ‘outperform’ to ‘neutral’, citing growth concerns. The brokerage house has also lowered the price targets for all three by more than 15 per cent each.

“We now forecast a lower value of new business (VNB) CAGR (compound annual growth rate) at 9-15 per cent for FY23-26E (financial years 2022-23 to estimates for 2025-2026) versus 16-22 per cent for FY22-25E. The near term catalysts are missing. Unless growth picks up meaningfully, sector performance will lag. Valuation support implies limited downside,” said Suresh Ganapathy, head of financial services research at Macquarie Capital in a note.

Shares of all three companies ended on a soft note on Friday with ICICI Pru Life declining the most by 3.5 per cent to end the day at Rs 495 apiece.

“The VNB CAGR over the past five years (FY18-23) for the private sector has been 17-30 per cent, largely driven by record level of margins, closer to 30 per cent for most large players versus sub 20 per cent five years ago. We believe margins have more or less peaked, and we don't expect it to support VNB growth this cycle. Additionally, with recent tax changes, there should be an impact on growth,” he added.

This year’s Union Budget 2023-24 has limited the income tax exemption on the proceeds of high value life insurance policies. Under this, only income from life insurance policies with an aggregate premium of up to Rs 5 lakh will be exempt from taxation.

In the past one year, insurance stocks have underperformed the benchmark Nifty50 by close to 13 per cent. As a result, the valuations of companies in this sector are one or two standard deviations below historical averages. However, for valuations to look compelling at these levels, Macquarie believes the growth in VBN has to be over 20 per cent.

“We believe that the markets won't be enthusiastic about a sub-optimal 9-15 per cent VNB growth this cycle. Consequently, multiples could remain depressed. We think growth is the single biggest catalyst for the sector. April 2023 numbers have been weak, but we won't read too much into one month's numbers,” Ganapathy has said.

At present, HDFC Life trades at 15.3x its projected VNB for FY25, while ICICI Pru and SBI Life trade at 8.1 times and 9.5 times, respectively.

Macquarie says HDFC Life historically has “shown exceptional ability to manage impact of regulatory changes and government policy changes on tax etc. through product innovation and enhancing distribution capabilities.”

“Hence, in our model we continue to forecast an above industry Rs 15 per cent VNB CAGR for them over the next three years. For the overall private sector life insurance industry overall VNB CAGR could be sub 10 per cent in our view in this cycle.”