27 June 2016 EQUITIES AIA Group (1299 HK) INSURANCE Buy: Our conviction still high after examining bear case Hong Kong AIA is our most preferred Asian insurance stock; the ultimate MAINTAIN BUY ‘compounder’ for a quality-biased investor TARGET PRICE (HKD) PREVIOUS TARGET (HKD) We are even more positive on AIA after examining the 10 56.00 54.00 main bear arguments SHARE PRICE (HKD) UPSIDE/DOWNSIDE Reiterate Buy, raise target price to HKD56 (from HKD54), 45.50 +23.1% implying 23% potential share price upside (as of 22 Jun 2016) MARKET DATA AIA is our most preferred Asian insurance stock. We regard AIA as the ultimate Market cap (HKDm) 542,225 Free float 100% ‘compounder’ stock for a quality-biased investor in the high growth potential Asian Market cap (USDm) 69,880 BBG 1299 HK 3m ADTV (USDm) 121 RIC 1299.HK insurance sector where shareholder returns are not always prioritized (they are at AIA). We have a high conviction Buy rating on AIA for many reasons, not least its FINANCIALS AND RATIOS (HKD) Year to 11/2015a 11/2016e 11/2017e 11/2018e defensive qualities, growth outlook, management quality, high free cash flow generation, IFRS EPS 1.81 2.13 2.91 3.20 attractive valuation (with catalysts), diversified country exposure, conservative risk IFRS EPS (prev) - 2.35 3.04 3.44 Change (%) - -9.6 -4.3 -7.0 management and focused Asian life strategy. Although AIA shares have outperformed Consensus EPS - 2.29 2.79 3.07 the Asian insurance sector by a notable 74% since listing on 29 October 2010 and PE (x) 25.1 21.4 15.6 14.2 Dividend yield (%) 1.5 1.7 2.0 2.2 18% over the past 12 months, we believe AIA shares should have delivered more were it not for several niggling bear concerns, which we address in this report. 52-WEEK PRICE (HKD) 59.00 Ironically, we gain comfort from examining these frequently cited bear 46.50 arguments against AIA. Indeed, in our view (1) AIA is not that sensitive to falling interest rates, (2) AIA shares are not expensive, (3) AIA’s morbidity risk is not a 34.00 Jun 15 Dec 15 Jun 16 significant concern, and (4) AIA is unlikely to be hit hard by the much-talked-about Target price: 56.00 High: 52.85 Low: 37.25 Current: 45.00 clampdown on life sales to mainland Chinese in Hong Kong. In addition, (5) while AIA Source: Thomson Reuters IBES, HSBC estimates is successfully deriving an increasing portion of its business from mainland China, James E Garner*, CFA AIA China has a vastly different risk/quality profile from its listed Chinese peers which Head of Financials Research, Asia Pacific the market is bearish on. Moreover, (6) we believe AIA’s NBV growth can continue to The Hongkong and Shanghai Banking Corporate Limited [email protected] grow at the current impressive rate, (7) we are not concerned about the evolution of +852 2822 4321 the management team, (8) credit spreads are widening in only three of AIA’s 18 Christopher C W Chan* markets, and (9) we see little chance of AIA shares being de-rated owing to a Insurance Analyst The Hongkong and Shanghai Banking Corporate Limited migration to a P/BV approach. Lastly, (10) USD appreciation is likely to abate, [email protected] enabling growth rates to improve against USD-depressed historical numbers. +852 2822 2895 Jianwei Yang* AIA is scheduled to report its interim results on Thursday 28 July at 6am, Hong Insurance Analyst The Hongkong and Shanghai Banking Corporate Limited Kong time. We detail our key expectations in this report, though it is too early to form a [email protected] consensus. We set our HKD56 target price using a 2.2x fair P/EV multiple derived +852 2914 9575 using a Gordon growth model formula where the key inputs are 14.1% ROEV, 3.5% terminal growth, and an 8.4% cost of equity. *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations Disclaimer & Disclosures Issuer of report: The Hongkong and Shanghai Banking Corporation Limited This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it. View HSBC Global Research at: https://www.research.hsbc.com EQUITIES INSURANCE 27 June 2016 AIA Group Financials & valuation P&L summary (USDm) Group valuation metrics Year to Nov 11/2015a 11/2016e 11/2017e 11/2018e Year to Nov 11/2015a 11/2016e 11/2017e 11/2018e TWPI 19,876 21,720 23,678 25,829 P/EV Group 1.8x 1.7x 1.5x 1.3x TWPI growth, % 3% 9% 9% 9% – Group RoEV 5% 12% 15% 16% OPAT margin 18.0% 18.2% 18.5% 18.7% P/ Tangible NAV 2.5x 2.1x 1.9x 1.8x OPAT 3,585 3,953 4,380 4,830 P/ book value 2.4x 2.0x 1.9x 1.7x OPAT growth, % 10% 10% 11% 10% – RoE 9.2% 10.2% 12.4% 12.4% Net gains equities (717) (662) 119 119 – RoE comprehensive -2% 21% 13% 13% Other non-operating (76) 0 0 0 P/E 25.1x 21.4x 15.6x 14.2x Net profit 2,792 3,291 4,499 4,949 Dividend yield 1.5% 1.7% 2.0% 2.2% Growth, % -24% 18% 37% 10% Per share date (HKD) Operational metrics Year to Nov 11/2015a 11/2016e 11/2017e 11/2018e Year to Nov 11/2015a 11/2016e 11/2017e 11/2018e EV group 24.71 26.95 30.05 33.78 NBV 2,198 2,815 3,574 4,463 – growth 3% 9% 12% 12% Life NBV growth, % 19% 28% 27% 25% TNAV 18.04 21.32 23.41 25.67 NBV/ APE margin 55% 58% 60% 61% – growth -3% 18% 10% 10% APE 3,991 4,876 5,991 7,352 Book value 19.22 22.50 24.59 26.85 APE growth, % 8% 22% 23% 23% – growth -4% 17% 9% 9% Life RoEV 10.2% 12.2% 14.6% 15.5% EPS 1.81 2.13 2.91 3.20 Life NBV/ Opening Group EV 5.9% 7.4% 8.6% 9.6% – growth -24% 18% 37% 10% HKICO solvency ratio 428% 462% 490% 497% DPS 0.70 0.78 0.90 1.02 – growth 39% 12% 15% 13% Embedded value (USDm) Year to Nov 11/2015a 11/2016e 11/2017e 11/2018e Issuer Information ANW 15,189 20,262 23,490 26,983 Market cap (HKDm) 542,225 Value of in force 23,009 21,405 22,969 25,232 Market cap (USDm) 69,880 Embedded value (USDm) 38,198 41,666 46,459 52,215 Free float 100% EV growth, % 3% 9% 12% 12% a Valuation changes New Old Change 2016e ROEV 12.2% 12.9% -0.7% 2017e ROEV 14.6% 14.1% 0.4% 2018e ROEV 15.5% 15.1% 0.4% Average ROEV 2016-18e 14.1% 14.0% 0.1% Sustainable growth 3.5% 3.4% 0.1% Cost of equity 8.4% 8.5% -0.1% Implied multiple (x) 2.2x 2.1x 0.1x EV p/s (HKD) 27.0 27.6 -2.4% Fair value end-2016e 58.2 57.3 1.6% 12-month fair value (HKD) 56.1 54.5 3.0% Valuation discount 0% 0% 0% Price target (HKD) 56.0 54.0 3.7% Price relative 57.00 57.00 52.00 52.00 47.00 47.00 42.00 42.00 37.00 37.00 32.00 32.00 2014 2015 2016 2017 AIA Group Ltd Rel to HANG SENG INDEX Note: Priced at close of 22 June 2016 Source: HSBC 2 EQUITIES INSURANCE 27 June 2016 Contents Executive summary 4 Multiple reasons to be positive 12 Addressing the bear concerns 19 What to expect from 1H16 results 38 Valuation and estimates 39 We examine 10 of AIA’s major life markets 41 Disclosure appendix 52 Disclaimer 55 3 EQUITIES INSURANCE 27 June 2016 Executive summary AIA is our most preferred Asian insurance stock; the ultimate ‘compounder’ for a quality-biased investor We are even more positive on AIA after examining 10 bear arguments Reiterate Buy rating on AIA, raise target price to HKD56 (from HKD54), which implies 23% share price upside Many reasons to prefer AIA over other Asian insurers Buy rated AIA remains our most preferred Asian insurance share. We regard AIA as a long-term We regard AIA as a long-term ‘compounder’ stock that has ‘compounder’ stock with many attractive features for a quality-biased investor, especially in the many attractive features for a Asian insurance sector where shareholder returns are not always prioritised. Buy rated AIA quality-biased investor remains our most preferred Asian insurance share for a host a reasons, including the following: Value-oriented, well-regarded management team, led by CEO Mark Tucker. AIA is one of the few insurers in Asia that is willing to sacrifice volume in its pursuit of value creation. Unique play on high profit growth potential Asian insurance markets. AIA operates in 18 markets, many of which offer among the highest growth potential in the world by virtue of a low life penetration rate, a growing middle class, and a relatively high GDP growth outlook. Even Developed Asia offers a significant ‘protection’ opportunity, which AIA continues to execute on successfully in Hong Kong and Singapore.