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Rising corporate bond yields in China are good for insurers: Adding China Life as a stock pick in the PIcks portfolio
12/04/2013 7:05 pm EST
That’s not terrible news—or at least not as terrible as it would be for U.S. companies. Bonds play a still small (but growing) role in financing companies in China. Most financing comes in the form of bank loans.
And it’s really great news for China’s insurance giants such as China Life Insurance (LFC as an ADR in New York) and Ping An Insurance Group (2318.HK in Hong Kong and a reasonably liquid PNGAY in New York.) That’s because China’s insurance companies, required to invest a big share of their portfolios in fixed-income products, are finally seeing rising yields on those investments. A 1.75 percentage point increase in yield is a big deal for these companies—especially if there’s more where that came from. Proposals from the recently concluded Third Plenum of the Communist Party’s Central Committee that point to further efforts to increase the role of the market in setting interest rates certainly point in that direction.
Of the two big insurers, Ping An is at this point the better company and the better long term bet. The company has what analysts judge the most productive life insurance sales force in the industry and a first-mover edge in direct marketing automobile insurance by phone. (The company uses an agency model for its life insurance sales, which gives it an advantage over peers that rely to a greater degree on selling through banks.) The first half of 2013 saw Ping An report a mid-teens growth rate for new business in its life insurance unit—the second six-month period in a row where the company has hit that growth rate. Margins in the personal and casualty unit rose even against increased competition in the segment. The one drawback to Ping An is a weakly capitalized banking unit. A long-drawn out battle with regulators has hindered Ping An’s efforts to inject capital into the bank. The weakness of the bank’s capital position is the major reason that Ping An trades at a 10% discount to China Life even though the company has shown significantly greater growth momentum.
It’s a lack of that growth momentum that has resulted in a paltry 13.5% 12-month gain for China Life’s New York traded ADRs versus the 30.8% gain for New York traded PNGAY. And all of that gain has come in the last month as the ADRs climbed 24% to $49.12 on December 4 from $39.66 on November 13.
In the first half of 2013 China Life saw the value of new business climb just 0.8%, and new sales through agencies drop 2% despite a 1% increase in the number of agents.
What’s attractive to me about China Life—and leads me to give it a nod over Ping An in the near term (although there’s no reason you can’t own both with China Life representing more of a trading play thanks to the ample liquidity in the New York ADRs)—is the leverage that China Life’s huge investment portfolio gives the company on any increase in yields (and in stock prices.) Credit Suisse projected a 34% increase in normalized investment income for 2013 from 2012 back in August—before the current increase in yields had played out. Back then, too, the stock was trading near all-time lows on price-to-book and price-to-earnings so the big rally since November 13 has taken off from a very low base.
The other reason to give the nod to China Life is that new regulations (set to be effective on January 1) change the game in selling insurance through banks so that insurance company agents will be able to return to bank branches for the first time since 2010. Given that about 24% of China Life’s new life insurance business comes through this bank sales channel now—a significantly bigger percentage than the 6% at Ping An—the new rules could well produce some of the growth that China Life has been missing lately.
I’d put a $61 an ADR target price on China Life (24% above the December 4 price) and $22.50 (17% above the December 4 price) on Ping An’s ADRs.
I’m adding China Life to my Jubak’s Picks portfolio http://jubakpicks.com/ today, December 4 with a target price of $61 an ADR for July 2014.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/, I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund did not own shares of China Life or Ping An as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/.
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