What happens when you get a better business, for cheaper valuations? You buy it! And that’s essentially what SBI Life Insurance offers.
It’s a great business with better metrics than its peers and has been available for cheaper valuations despite demonstrating strong execution capabilities.
We reckon it’s time for the stock to start getting valued fairly, for the immense outperformance opportunity it offers.
It is superior on most operating metrics:
Unmatched distribution: SBI Life Insurance’s SBI parentage gives it an unmatched advantage - access to the country’s largest banking distribution channel, which provides a long-term growth opportunity. Moreover, PSU bank’s consolidation provides an added clientele to be tapped into. More than 60% of its products are distributed through the banking channel.
Lowest cost structure: Because of its distribution channel, SBI Life has been able to maintain the lowest cost structure in the industry. Its opex ratio (ratio of operating expenses to the net premium income) stands at 5.2% in FY22 compared to HDFC Life’s whopping 12.4%, and ICICI Pru’s 10.1%.
Improving business mix: SBI Life has been increasingly focused on the Protection segment, which offers better margins. The strong execution of this strategy can be seen from the fact that this business contributed to nearly 40% of the APE (Annual Premium Equivalent), from 20% a year ago. This also makes the incremental composition of Protection the highest amongst peers.
Strong VNB growth: VNB = Value of New Business, and is a key metric of profitability. The rising share of Protection enabled 20-35% CAGR for insurance players over FY17-20, and that growth trend continues to drive higher growth. VNB was up 132% YoY for SBI Life Insurance in 1QFY23 - nothing short of dramatic.
Better growth prospects: Stronger distribution and a better product mix are likely to enable SBI Life Insurance to see a premium growth of 25% on a sustainable basis, which the management also aims for. With this growth, SBI Life has been consistently gaining a higher share in the insurance industry, from both private and public players.
Despite the superiority of its business, SBI Life trades at a discount to its peer HDFC Life. The FY24 Price to Embedded Value (a metric commonly used to determine an insurance firm's worth) for SBI Life stands at 2.2x, versus 2.6x for HDFC Life.
Essentially, SBI Life is trading at a 20% discount to HDFC Life despite its larger business, higher growth, larger opportunity, lower cost structure and higher profitability.
We think this discount is unjustified, and should turn into SBI Life either trading at par, or at a premium to HDFC Life.
For the Curious: How to Value An Insurance Company
Understand the Embedded Value (EV): Embedded Value represents the company's current value without taking into account its capacity to generate new business. This hence becomes the value of the company based on the policies it has already sold, plus the value of its free capital.
Add Value of New Business (VNB): Value of New Business (VNB) is the operating and incremental increase to EV resulting from New Business written during the year.
Get the Appraisal Value: Embedded Value and Future Estimated New Business Addition are added together to determine an insurance firm's fair value. In the insurance market, this number is referred to as the "Appraisal Value".
Assign a multiple to the EV: Basis historical levels, peer comparison, or future expectations assign a multiple to the EV and get the target value of the business.
Divide by the number of shares: Divide the arrived value by the number of shares and you have the price per share!