The "China Worry" Effect
03/14/2014 11:00 am EST
Fear and worry about China's economy and financial system appears to be taking its toll on China's leading insurers, and MoneyShow's Jim Jubak, thinks that's why it's important to look for a financial company in China that's firing on all cylinders.
Ping An Insurance Group ((PNGAY) in New York and (HK:2318) in Hong Kong) kicked off earnings reporting season for China’s big insurance companies yesterday. Ping An, China’s second largest insurer, reported a 40.3% gain in net income for 2013.
That 40% gain in net income is likely to be among the lower increases reported by China’s insurance companies in the next few weeks. The average growth in net income among insurers expected by analysts is 92%. I think that makes it worthwhile holding the best of these insurers—such as Ping An and China Life (LFC), a member of my Jubak’s Picks portfolio, for these earnings reports, even though the systemic stress—and thus risk—in China’s financial system is rising.
I would, however, take a hard look at risk at specific companies after they’ve reported, to judge how exposed to these systemic risks each might be.
Ping An isn’t your average Chinese insurance company. The big increase in new income in 2013 was a result of a 13% increase in net premiums and a 14% increase in profits at the company’s banking arm. Ping An relies less on selling insurance through banks than the average Chinese insurer—a plus, since this business carries very slim margins—and the company has been at the forefront of innovations, such as online sales (in its auto insurance lines). On the downside, especially in the current state of the financial sector, Ping An has a big banking arm. In 2012, impairment losses at the bank doubled. In 2013, impairment losses fell from the 10 billion yuan of 2012 to 8.97 billion yuan. Bank income also rose, as long margins increased. But the bank isn’t without its problems, according to analysts. For the year, analysts at Sanford C. Bernstein wrote, on March 7, the lender delayed recognition of some non-performing loans that could have, the analysts argued, cut net income by half. Ping An’s bank is a key reason that the stock trades at a 10% discount to peers such as China Life.
That company isn’t without its problems itself. At China Life, though, the issue is a lack of growth in new business—China Life is much more dependent on sales through banks than Ping An, and this channel simply hasn’t been very effective. New business value, a measure of the profitability of new business, has lagged peers. Still, back in January, China Life guided investors to a 120% increase in net income in 2013 over 2012. The cause of that, the company said, was a big jump in investment income resulting from better performance among Chinese stocks in 2013 than in 2012.|pagebreak|
The good news for investors and traders waiting for China Life’s March 26 earnings report is that the January guidance of 120% gains in net income was a major disappointment. Analysts had been projecting growth of 160%. The stock, which had rallied 13.3% from February 5 to February 19, making up almost all the ground it had lost from its January 22 high at $45.12, has given all that back and a little more in recent days. Shares have tumbled 14.6% from February 19 through March 12.
In my opinion, that drop, and the disappointment over guidance for only a 120% gain in net income, increase the chance that China Life will move up on actual earnings reported on March 26.
How much the ADRs (American Depositary Receipts) will move up, even on a substantial beat, is an open question given the worries about China’s economy and financial system. Currently. Ping An was off 1.29%, even after its report at the New York close on March 13.
Should you hold after the results are in? A lot depends, in my estimation, on what China Life says about premium income from life insurance. Premiums in the life insurance sector were up a record 88% in January, according to Sanford C. Bernstein, as some investors and savers decided to put money into “safer” life insurance products, instead of higher-yielding, but riskier, trust products. If that trend looks likely to continue, according to China Life, then maybe, just maybe, China’s life insurers might actually be beneficiaries of rising worries about China’s financial sector. I’d also check growth in new business value at China Life to see if the company has been able to generate any growth in that metric.
It will be tough for any financial stock to move up in the first half of 2014 against the environment of worry about the financial system. At the least, you should look for a financial company that’s firing on all cylinders.
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, 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 as of the end of December. For a full list of the stocks in the fund see the fund’s portfolio here.