Bajaj Finserv: BUY. A premium opportunity

The long-pending Insurance Laws (Amendment) Bill, 2015 was passed in the Rajya Sabha recently. This has now increased the FDI limit in insurance from 26 per cent to 49 per cent. There are many companies in the financial services space that have a large portion of their overall business driven by their insurance subsidiaries. These companies will stand to gain from the substantial unlocking of value in their insurance businesses, since the increase in FDI limit could lead to the listing of the insurance companies. This will provide a better valuation benchmark.

Bajaj Finserv has 74 per cent stake in both Bajaj Allianz Life and Bajaj Allianz General Insurance. It also has a 61.5 per cent stake in Bajaj Finance, one of the leading non-banking financial companies. The life insurance business contributed about half and the general insurance business a fifth of the consolidated earnings in 2013-14.

In the run up to the passing of the insurance Bill, the stock has rallied sharply over the last year. From our previous Buy recommendation last June, the stock has gained about 50 per cent. But given that the company is one of the few listed players that stands to benefit substantially from the passage of the Bill, investors with a two-to-three year horizon can still buy the stock. At current levels, there is scope for further upside. Bajaj Finserv has been valued on a sum-of-the-parts (SOTP) basis. The life insurance business is valued using the appraisal value method, and the general insurance business on a price-to-earnings basis. For Bajaj Finserv, about 40 per cent of its value comes from the life insurance business and about a quarter from general insurance.

Bajaj Finserv’s holding in Bajaj Finance has been valued at a 20 per cent discount to latter’s current market price. Adding these, the SOTP value of Bajaj Finserv comes to Rs 1585, implying about 17 per cent upside from current levels.

The passage of the insurance bill should help increase the penetration of insurance in the Indian market and bring in more transparency and better standards of governance. Access to capital will also help large players to look at the acquisition route for growth.

Bajaj Allianz ranks among the top five in the life insurance space in terms of new business premium. The last couple of years have been challenging for life insurance players due to a weak economic environment and regulatory changes such as tighter guidelines on ULIPs.

Nevertheless, the company has remained profitable since 2009-10.

Its solvency ratio was a healthy 734 per cent in 2013-14, much above the minimum regulatory requirement of 150 per cent. With the economy showing signs of revival, the new business premium can grow by 10 per cent annually over the next two years.

In the general insurance space, Bajaj Allianz ranks second among private players (based on gross premium). The company has been one of the most profitable insurers. In the nine months ended December 2014, profit grew 36 per cent year-on-year. The motor business forms the chunk of the business portfolio (59 per cent share), while health and property account for 15-16 per cent. Bajaj Allianz should continue its growth momentum, with earnings expected to grow 25-30 per cent over the next two years, driven by its health and motor portfolio.

Bajaj Finance, one of the leading non-banking financial companies (NBFCs), delivered strong earnings growth of 24 per cent in the first nine months of 2014-15. Healthy traction in consumer finance and SME lending have led to a faster-than-industry growth. The company also has low loan delinquency compared with its peers. It has already adopted the higher provisioning and early recognition of non-performing asset norms ahead of the regulatory requirement.

As on December 2014, the company’s loan book grew 37 per cent over last year. The gross non performing assets stood at a low 1.5 per cent as of December, with 95 per cent of the loan portfolio already conforming to the 90-day norm for classification of non performing assets.

There is however a risk. The value of both insurance businesses is calculated based on Bajaj Finserv’s 74 per cent stake in them. However, Allianz (foreign partner) has a call option to increase its stake to 74 per cent subject to regulatory approvals.

This option expires on July 2016. With the FDI limit for insurance increased to 49 per cent, the value of these businesses at 51 per cent stake accruing to Bajaj Finserv could come down. But reports suggest that stake dilution, if and when it happens, will be at market rates and not unfavourable to the company.

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