Stake hike, operational improvement should drive re-rating in ICICI Lombard

Most analysts are positive on the stock with target prices between Rs. 1,250 and Rs. 1,630

The ICICI Lombard stock has shot up due to precedence set by a key clearance given for the HDFC- HDFC Bank merger. After ICICI Lombard General Insurance Company merged with Bharti-Axa in September 2021, the ICICI Bank stake in the insurer had dropped to 48 per cent. Under RBI regulations, the bank was then compelled to reduce its stake to 30 per cent, by September 2024. However, once the HDFC-HDFC Bank merger was announced, the merged entity’s stake in HDFC Life would also have dropped below 50 per cent and the central bank agreed to allow the merged entity (which would be a bank) to hold over 50 per cent. This sets a key precedent for ICICI Bank to also raise its stake beyond 50 per cent in ICICI Lombard and the lender has just announced that it will do so.

Investors had seen the ICICI Bank’s compulsion to sell off 18 per cent of its stake as a major negative for the valuation of ICICI Lombard. Quite apart from the operational situation for the insurer, the prospect of the stake dilution led to a selloff and the PE ratio dropped from 55x prior to the merger with AXA, to around 28x currently. The announcement that ICICI Bank will be allowed to push its stake back up has led to a massive surge in the share price of the general insurer. The assumption is that the necessary regulatory approvals for the stake increase will be granted and the valuation upgrade will be sustained.

On the operational side, the merger should help with synergies related to technology, economies of scale, and an improvement in the health premium mix. All this should translate into an improving Combined Ratio and better RoE (return on equity). After the Combined Ratio hit a dangerous high of 109 in FY22, it has reduced to 104.5 in FY23 and analysts believe it will reduce further through the next two fiscals. Combined Ratio indicates the profitability of an insurance company. It is calculated by adding the claims and expenses and dividing the sum by the premium income; lower the ratio, the higher profitability. The RoE has also improved from 15.5 per cent in FY22 to 17.7 per cent in FY23 and it should also improve further.

Overall, a drag has been the poor motor loss ratio, up from 65.8 per cent in FY21 to 71 per cent in FY22 and 72.4 per cent in FY23. The management guidance indicates that a recovery in motor loss ratio and strong traction in the health (group as well as retail) segment will bring the Combined Ratio down to 102 by FY25.

ICICI Lombard hopes to drive higher penetration through digital efforts, comprising: (1) expanding reach, (2) increasing possible products per customer, and (3) embedding products across platforms encompassing call centres, relationship managers, website, mobile apps and physical branches.

The share price has jumped by 8 per cent to Rs 1,190 on the news. Analysts have positive recommendations on the stock with target valuations ranging from Rs 1,250 to Rs 1,630. According to Bloomberg data, six of the eight analysts polled in May have a buy/add/overweight rating, two have a hold; their average target price is Rs 1,422.