AIA Group - Expect strong pent-up demand in FY23F
- Revise down FY22/23F VONB by 11%/9% to reflect 1) impact from China’s 2Q lockdown measures and 2) as HK/China border reopening more likely in FY23F
- Strong pent-up demand expected from HK market once HK-China border reopens
- Concerns overdone on recent sharp US interest rate hike and MTM impact to bond portfolio, given low EV sensitivity to interest rates
- Revise down FY22/23F earnings by 6%/2% to reflect slower investment income growth. Roll over valuation base to FY23F and lower TP to HK$124 on lower multiple
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We lower AIA’s FY22/23F VONB growth assumption by 11%/9%, respectively, so as to factor in a) the impact from China’s lockdown measures in 2Q22, which affects growth for the quarter and beyond; b) the expectation that the VONB margin in China is to be impacted by the industry-wide annuity product mix shift; and c) that the HK-China border is more likely to reopen in FY23F, compared to the previous expectation of 2H22F. With AIA’s VONB growth in 1Q22 posted a decline of 18% y-o-y under a constant exchange rate (CER) basis, mainly due to a high base from last year and impacts from the Omicron wave in the various markets it operates, we expect the magnitude of its y-o-y decline in 2Q22F to narrow and resume a positive y-o-y growth trajectory moving into 2H22F. Overall, we expect its VNOB growth to post a marginal reduction of 1% y-o-y in FY22F.
However, with the expectation that the HK-China border is likely to reopen in FY23F, considering the infectiousness of COVID-19 is becoming more balanced between HK-China, and with the China market likely to resume its stronger growth rebound, mainly due to a low base and continuous expansion into new territories, we expect AIA’s VONB to post a 17% y-o-y growth in FY23F.
Strong pent-up demand expected from MCV segment once border reopens.
Despite there being no official timetable for the reopening of the HK-China border, the recent statements from newly elected Hong Kong Chief Executive John Lee seem to be increasingly constructive (Fig 1). Moreover, we believe that the announcement on 30 June 2022 that China would reduce the quarantine days for overseas arrivals from “14+7” days previously to “7+3” days also represents the first move in easing border restrictions.
Furthermore, we believe the infectiousness of COVID-19 between HK and China is a pre-condition for border reopening, and as the infection levels between the two countries becomes more balanced, we may likely see borders reopening in FY23F, in our view.
Once materialised, the reopening of the border should provide a strong boost to AIA’s Hong Kong business, given that the Mainland China Visitor (MCV) segment has accounted for two-thirds of AIA Hong Kong’s annual premium equivalent (APE) at its peak level; the percentage has dropped to merely 1% since the outbreak of the global pandemic (Fig 2).
Accompanied by the robust growth from the domestic segment, we are expecting VONB growth in AIA Hong Kong to be +6% y-o-y in FY22F and accelerate to +27% y-o-y in FY23F, serving as one of the key growth drivers for VONB growth in FY23F at the group level.
Concerns overdone on bond portfolio mark-to-market impact from sharp US interest rate hikes.
There are rising concerns in the wake of the recent incident with Nanshan Life (non-listed), Taiwan’s third largest life insurance company, which book value in 1Q22 declined by 37% compared to end-FY21 (Fig 3, vs. average reduction of 14% among its major listed peers) on mark-to-market (MTM) loss resulting from its sizeable USD bond portfolio due to the rise in the US bond yield as well as the global equity market correction. As the US interest rate hikes further accelerated in 2Q22, along with a steeper global equity market correction during the quarter, the market is expecting the insurer’s book value in 2Q22F to decline at an even steeper rate. This has led to further market concerns over the MTM impact to regional insurance companies, such as AIA, as a result of the rise in the USD bond yield.
In general, an interest rate upcycle is considered a positive for insurance companies, as the rise in interest rates (or bond yields alike) will enhance insurance companies’ reinvestment returns, and the higher investment return can transform to higher margins for the business already written. Higher investment returns also imply that less liability reserves are required for new products. For insurers that focus on the spread business, higher yields also help to expand its spread income.
We believe one of the main reasons for seeing such a drop in the book value of Nanshan Life is because insurance companies in Taiwan tend to allocate more investment assets to USD-dominated bonds in order to earn stable bond yields and lengthen the duration, as the interest rate level in Taiwan has remained relatively low due to the issue of over-banking and access to liquidity. Given IFRS 9, insurance companies are required to MTM its assets and with US interests rates rising in a sharp manner, this will temporarily impact insurers’ asset values. Furthermore, the benefit on the liability side is not duly reflected, as the global adoption of IFRS 17 (rise in interest rates will lead to reduced liability reserves) will only be implemented from 2023, while Taiwanese insurance companies will delay adoption until 2026. Combine the above factors, this will cause a temporary sharp drop in insurance companies’ book values. In addition, the MTM impact from insurance companies’ bond portfolios is usually considered a non-cash item, given that insurance companies tend to choose hold-to-maturity on its bond investment account bookings, for the purpose of matching asset-liability durations.
Limited impact to AIA, given the low interest rate sensitivity of EV.
As AIA adopts a liability-led duration-matching strategy and its business mainly focuses on protection and long-term savings rather than spread products, the overall interest rate sensitivity of its embedded value (EV) is actually low. In addition, AIA also has a variety of management actions and risk management tools in place, i.e., hedging strategy to protect from the risk of low interest rates, to manage its risk exposures. While its sizeable HK business is considered more sensitive to US interest rate volatility, due to the nature of the liability where AIA holds a substantial amount in participating business, its strict adoption of the asset-liability matching strategy ensures its interest rate sensitivity is relatively less. Overall, we believe the MTM impact on AIA’s bond portfolio and balance sheet that resulted from the rise in US interest rates is limited and manageable.
Lower TP to HK$124. Reiterate BUY.
We lower FY22/23F earnings by 6%/2% to reflect the lower investment income growth due to higher market volatility in 1H, as well as the smaller scale benefit, given the impact of the Omicron wave. Factoring in slower VONB growth, rolling over our valuation base to FY23F, and now based on 1.8x P/EV multiple (previously based on 2.1x FY22F P/EV), we lower TP to HK$124 (from HK$127). With a 56% share price update, we reiterate BUY. AIA remains one of our top picks within this space.
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