Stock Call. What sweetens the deal for ICICI Lombard?

In what could set the stage for a spate of consolidation moves within the general insurance industry, ICICI Lombard recently entered into an agreement with Bharti AXA General Insurance to acquire the latter’s non-life business. Bharti AXA GI’s non-life insurance business will be demerged into ICICI Lombard.

The all-stock deal is pegged to make ICICI Lombard the third-largest general insurance player (in terms of gross direct premium income or GDPI), from being the fifth currently.

The deal, of course, hinges on various regulatory approvals that could take time.

While the deal could bring in long-term revenue and cost synergies, an expensive deal price against Bharti AXA’s weak profitability metrics (loss-making in FY20), the ability of ICICI Lombard to leverage Bharti AXA’s bancassurance tie-ups and optimise cost structure (Bharti AXA has a high opex ratio) are some concerns around the transaction.

Also, ICICI Bank’s stake in ICICI Lombard would fall to 48 per cent after the deal (from 51.89 per cent as of June).

Whether the regulator will give sufficient time for ICICI Bank to bring the stake to below 30 per cent (regulations do not allow holdings between 30 per cent and 50 per cent), is another overhang that needs a watch.

That said, ICICI Lombard’s sound underwriting skills, strong execution of growth strategy in profitable businesses and sound financials are key positives that could help drive synergies out of the deal. While the deal could be EPS (earnings per share) dilutive in the near term, it is expected to turn EPS and ROE (return on equity) accretive in the medium term (1-2 years).

At the current price, ICICI Lombard trades at about 4.3 times FY20 gross written premiums and 49 times earnings. While the stock is pricey, its healthy financials and strong leadership position can continue to drive premium valuations.

ICICI Lombard’s long-term focus on profitable segments — remaining selective in businesses it underwrites, a healthy solvency ratio, market leadership and strong focus on technology — also augurs well for long-term earnings prospects.

The deal with Bharti AXA, if it comes through, can add value to ICICI Lombard’s business over the long run, though there could be near-term pain.

Investors with a long-term horizon and looking to ride the opportunities in the general insurance space can continue to accumulate the stock at this juncture.

Revenue synergies

ICICI Lombard expects the combined entity’s market share to scale up to around 8.7 per cent (in terms of GDPI based on FY20 pro-forma figures) from 7 per cent currently. Revenue synergies from the deal are expected to flow in from leveraging Bharti AXA’s tie-ups with leading private banks and its healthy market share in the motor OEM (original equipment manufacturer) business.

In terms of product mix, both players have a strong focus on the motor OD (own-damage) segment. ICICI Lombard expects the merger to help consolidate its market position and increase penetration across OEMs.

Health is a segment that Bharti AXA is in the process of scaling up (11.6 per cent of GDPI).

However, health indemnity has been a strong focus area for ICICI Lombard (25 per cent of GDPI in FY20) and it plans to leverage Bharti AXA’s strong agency force of around 6,700 agents (mostly focussing on motor and SME segments, currently) to scale up its business.

Crop insurance, a business that ICICI Lombard exited last fiscal owing to uncertain underwriting risks, is a growth segment for Bharti AXA.

So far, Bharti AXA has been able to cap its losses in the segment at 54 per cent and 29 per cent in FY19 and FY20, respectively (calculated from public disclosures as a ratio of net claims paid to net premium earned).

The management of ICICI Lombard in the post-deal concall stated that it would continue to honour commitments under Bharti AXA’s crop portfolio (contracts for 2-3 years), and, thereafter, it will decide on whether to continue operating in the segment.

On the distribution front, ICICI Lombard is hoping to leverage Bharti AXA’s strong tie-ups with large private banks and also its strong agency force which has grown rapidly in the recent years. This will be critical to drive revenue synergies and market share gains.

On the bancassurance side, Bharti AXA has key tie-ups with leading banks such as HDFC Bank and Axis Bank. How well ICICI Lombard is able to leverage these tie-ups needs to be seen. Any setback on this front could be a dampener for growth.

Cost optimisation

Bharti’s AXA’s loss ratio (total incurred claims in relation to the total premiums) of 78.3 per cent is more or less comparable with that of other players (ICICI Lombard’s loss ratio is 72.8 per cent).

But its combined ratio at 120 per cent is on the higher side mainly due to a higher opex ratio. Optimising costs will be critical post the merger deal.

ICICI Lombard believes it will be able to reduce certain overheads such as branch infrastructure cost, information technology and branding. Also, as economies of scale kick in, costs should trend lower. As of FY20, Bharti AXA’s opex ratio (operating expenses by net premium, computed from public disclosures) stood at about 36.7 per cent vs ICICI Lombard’s 23.8 per cent.

Also, the commission ratio (net commission by net premium) of Bharti AXA is higher at about 5.4 per cent, while that of ICICI Lombard’s is about 3.8 per cent. How well the latter is able to re-negotiate terms with the former’s distributors to bring down commission ratio needs to be seen.

Bharti AXA had taken some write-offs on its investment assets in FY20. The general insurer has exposures to IL&FS, Dewan, Reliance Capital and YES Bank.

While YES Bank is provided for fully, the others still had a book value of about ₹112 crore as of March 2020. These investments may need further provision going ahead.

Deal valuation

The all-stock deal will entail issuance of fresh shares of ICICI Lombard to shareholders of BhartiAXA GI — two shares in ICICI Lombard for 115 shares of Bharti AXA GI. This values Bharti AXA GI’s business at about ₹4,500 crore (based on ICICI Lombard’s current market price).

This implies valuation of about 6.7 times book value and about 1.5 times its gross written premium or GWP (FY20).

The deal price appears expensive given that the company was making losses in FY20 and ranks 17th among general insurers with a 1.7 per cent market share (based on GDPI).

ICICI Lombard’s Q1 show

Amid the Covid-led lockdown and disruption, ICICI Lombard’s GDPI declined by 5.3 per cent in the June quarter. The pandemic impacted the motor business, with new vehicle sales taking a hit. Growth could be under pressure in the near term, with discontinuation of long-term insurance having some impact on business and profitability.

On the other hand, while the health insurance segment was also impacted in the June quarter, it is likely to gain over the long run from the growing awareness around such products post the pandemic outbreak. ICICI Lombard’s investment book stood at ₹ 28,118 crore as of June; solvency ratio stood at a strong 2.5 times against the regulatory requirement of 1.5 times.