Why I am bearish on PICC P&C?

China property & casualty (P&C) insurance company PICC(SEHK: 2328) has disappointed investors in recent years. Should you still be bearish on it? – Chinese flag in foreground with The Bund in Shanghai in the background

China has the second largest property & casualty (P&C) insurance market in the world. Yet, with a P&C insurance penetration rate of only around 1%, opportunities for P&C business abound.

As such, the Chinese P&C sector has experienced double-digit annual growth over the past five years, and investors are expecting such growth trajectory to continue in the future.

However, the share price of the P&C market leader in China, PICC Property and Casualty Company Ltd (SEHK: 2328), has disappointed. Since the beginning of the year, its share price has dropped by almost 35%, with a price-to-book value (PBV) multiple of 0.7x only.

In this article, we will look into whether such a low valuation will warrant a good entry window or shows the stock’s weak fundamentals and limited growth potential.

Let the numbers speak for itself

Auto insurance is, by far, the largest product in the Chinese P&C market. It accounts for more than 70% of the P&C market in China.

Since 2014, there have been gradual pricing deregulations of the auto insurance market. The result of the pricing deregulation is fiercer pricing competition in the auto insurance market.

As a result, driven by increase in user acquisition costs, there has been a deterioration in the underwriting profitability of the P&C insurers across the sector.

PICC P&C’s combined ratio, which measures its underwriting profitability (the lower, the better), has increased from 96.5% in 2014 to 99.2% in 2019. Similarly, Ping An P&C’s combined ratio has increased from 95.3% to 96.4% in the same period.

What is worth noting is PICC P&C’s combined ratio was lower (i.e., better) than Ping An P&C in 2013. The inflection point of Ping An P&C achieving better underwriting results than PICC P&C coincided with the pricing deregulation.

Scale is not enough

PICC P&C has a market share of around 30%, while Ping An P&C has about 20%.

Given the increasing price competition, economies of scale should help. This is true, as PICC P&C generally has a lower expense ratio (total expenses related to selling a policy / gross premium earned) than Ping An P&C.

However, the scale of PICC P&C mainly relies on traditional agency network which is getting costlier and more inefficient, as compared to the more direct, technology-driven sales approach embraced by Ping An P&C.

In 2019, PICC P&C sold 69% of its products through agency channel while for Ping An P&C, agency sales only took up less than 25% of its total sales.

Over time, we can expect PICC P&C to lose its scale advantage gradually and Ping An P&C to catch up with it.

PICC P&C failed to benefit from the new growth

Given its dominance, auto insurance will continue to drive the growth in China’s P&C market. The new wave of growth is expected to come from rural areas.

With increased technology adoption in rural China, Ping An P&C is in a much better position to benefit from this future growth through existing technology. It will be very costly for PICC P&C to tap into this via its currently established agency channel.

Thanks to its technological power, Ping An P&C can also enjoy more favourable pricing of its products, since it offers better insights into the customers’ behavior and preferences.

Foolish conclusion

In my opinion, PICC P&C’s position will continue to deteriorate and gradually lose out to Ping An P&C. Its muted share price performance and low valuation multiple do not reflect undervaluation at the moment.

More reading

The Motley Fool Hong Kong Limited( 2020

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