Ping An Insurance - No short-term capital needs for SDB acquisition

Ping An will finance the acquisition of SDB using internal capital. As the Group has about Rmb30b excess capital, we do not see a need for them to raise capital in the short term. Maintain BUY.

1. The share subscription will be financed by Ping An Life using non-PAR policyholder funds. The 19.79% stake in Shenzhen Development Bank (SDB) held by Ping An Life will be classified as an AFS investment.

2. Following the acquisition of the 520m shares owned by Newbridge Asia by Ping An Group, Ping An Life will then sell a 3.94% stake in SDB on the open market so that Ping An’s total stake in SDB remains below 30%. At this stage, Ping An will treat SDB as an associated company using the equity-holding method.

Capital not a concern for Ping An in the short term. The initial share subscription will cost Ping An Life some Rmb10b. We estimate Ping An Life to have Rmb10b-20b excess capital, therefore, there will be short-term pressure for a capital injection from the group level. However, in the long term, should Ping An aspire for a complete takeover of SDB, there could be a need for additional capital even on the group level as we estimate Ping An needs Rmb30b of excess capital on the group level if it is to maintain a solvency margin of 200%.

Will Ping An shares be subject to share-sale overhang if Newbridge opts for share swap? As Newbridge is a private equity fund focused on generating investment returns, it is almost certain that it will look to sell its stake in Ping An following the expiry of the lockup period in 30-48 months time. However, given that the possible amount of H-shares that can be obtained by Newbridge is only 3.9% of Ping An’s enlarged capital, both dilution and sharesale overhang will be minimal.

The implied premium for Newbridge’s SDB stake may create some investor concern. We calculate the implied price as almost Rmb30 per SDB share based on a share price of HK$57.15 for Ping An. This is almost a 40% premium to SDB’s share price of Rmb22.00.

Given the relatively small financial impact of the deal, we continue to maintain our earnings estimates for 2009 and 2010. However, we now roll forward our target price to 2010, and based on 2.6x 2010 P/EV and 25x NBV, we arrive at a new target price of HK$68.80. We continue to maintain our BUY recommendation.

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China Insurance Sector - Read-through from CIIH's profit warning

CIIH is the second insurance company in the HK/China market to release a profit warning after China Life. This may give rise to concerns about the read-through for Ping An and PICC.

These concerns are well founded, in our view. The FY08 reporting season is going to be terrible for the China insurers. But it should not come as a surprise. As owners of financial assets (including equities), insurers‘ results are inherently exposed to equity market fluctuations, and the 65% decline in the Shanghai Composite Index in 2008 is about as severe as it comes.

Ping An is expected to report a loss for FY08. This has effectively been flagged since October when they took an impairment charge on the Fortis stake. PICC is forecast to report an 85% YoY decline in EPS. With the 1H08 loss underpinned by large catastrophe losses, our FY08 EPS forecast implies a moderate 2H08 recovery.

Within the sector, we prefer PICC as we believe its 2H08 results will provide evidence of cyclical improvement in operating profits. Confession season underway Earnings ”confession season‘ continued with CIIH releasing a profit warning that indicated it expected to report a net loss for FY08. This follows on from China Life‘s recent announcement that its PRC GAAP earnings would fall by more than 50% YoY.

This naturally leads to concerns about who is the next to come out with a profit warning and how bad might it be. In this note, we consider the prospects for Ping An and PICC.

Ping An

We expect Ping An to release a profit warning in the coming weeks. Given its A share listing, it is required to guide investors in relation to abnormal movements in its earnings and the FY08 results should certainly be considered abnormal.

We expect a FY08 loss of Rmb5.1 bn, or Rmb0.69 in EPS terms. Despite the shock value of such a large loss, it should not really come as a surprise. Ping An took an impairment charge of Rmb15.7 bn on its Fortis investment in its 3Q results and the combination of further falls in the value of this investment plus additional declines in the broader equity market should be sufficient to transform the Rmb1.8 bn profit achieved in 9M08 into a sizeable loss.


PICC

It is unclear whether PICC will release a profit warning. Given it is not listed in the A Share market, we do not believe it is required to provide a guidance on material earnings changes; however, like CIIH, it may decide it is good corporate governance to do so.

We forecast PICC will report a net profit of Rmb465 mn, representing an 85% YoY decline in EPS. While this is clearly a disappointing result, we believe a weak headline has largely already been known by the market since August when PICC reported a 1H08 loss due to abnormal catastrophe claims costs and weak investment markets.

Ironically, we are looking for signs of encouragement in this coming result. We believe underwriting profitability will show early signs of recovery based on stabilisation of premium rates, easing pressure on commission rates and PICC‘s focus on trimming costs from admin and claims settlement. After a difficult 1H08, evidence of improvement in 2H08 would bode well for the outlook for 2009.