Four years of PICC P&C's slow bull

This year, everyone is criticizing the surge of stocks with "Zhong" in their name, regardless of the overall stock market situation. The higher they rise, the lower the dividend yield, similar to the past trend of consumer healthcare stocks.

The coal and oil industries have shown high earnings growth and dividend payout ratios, making it understandable why they are being favored. However, the unexpected new highs in bank stocks have surprised many. The real estate sector's performance is worrying, with unclear asset quality and a downward trend in long-term interest rates leading to a decrease in long-term interest rate spreads. Despite a fixed dividend payout ratio of 30%, bank stocks with high nominal dividend yields have still received attention this year.

Even more strangely, the two financial brothers of bank stocks, the insurance and brokerage sectors, have both performed poorly this year. Formerly the largest market cap company in the Shenzhen Stock Exchange, China Ping An has hit a new low. As we have mentioned before, do not forget about insurance stocks during the downturn. Life insurance companies in decline do not have much lower cost-effectiveness compared to banks. However, upon closer observation, some insurance stocks have managed to keep up with the bull market in the banking sector.

One such company is PICC P&C, a subsidiary of China People's Insurance Company, which has quietly risen for 4 years in the Hong Kong stock market, doubling its value in this environment. In the first three years, there was no talk of "Zhongtegu" (stocks with "Zhong" in their name).

Property insurance companies have relatively stable businesses, mainly focusing on car insurance with annual settlements. They do not face major liability duration issues due to declining interest rates, nor do they experience a decrease in car insurance purchases during economic fluctuations. With good cash flow and seemingly thriving with the development of new energy vehicles, could this be a very promising investment target?

I. PICC P&C ≠ PICC

PICC P&C is a subsidiary of China People's Insurance Company, commonly known as China Property Insurance. Referring to it as PICC P&C is also acceptable.

In the A-share market, 601319 China People's Insurance Company holds 69% of the shares of 02378 PICC P&C in the Hong Kong stock market. The difference between the two lies in the fact that PICC P&C is purely a property insurance subsidiary, while China People's Insurance Company includes both property insurance and life insurance businesses.

Property insurance business accounts for the majority of China People's Insurance Company's operations. Out of the total revenue of 553.1 billion in 23 years, 451 billion comes from property insurance and 100 billion from life insurance. However, due to only holding 69% of the shares, China People's Insurance Company's balance between property and life insurance is even higher than the income ratio.

The market is currently concerned about the mismatch in duration caused by the decline in investment interest rates in the life insurance business. In the future, as implied returns decline, policy values will continue to be reassessed and may even turn negative.

If China People's Insurance Company's life insurance business goes public, its performance is expected to be similar to China Life Insurance and Ping An Insurance. This explains why PICC P&C has performed much better than China People's Insurance Company, as the latter can be seen as a discounted version of PICC P&C with a drag effect.

On the other hand, PICC has not been listed on the A-share market for long, with a new stock valuation premium. Up to now, the PB of PICC in China is still higher than that of PICC P&C in Hong Kong, and the dividend yield is lower. Therefore, these two companies cannot be compared equally. Assuming optimism about the future of PICC P&C, choosing the A-share parent company as a substitute is not a good idea.

Currently, the core of PICC's business is car insurance, which accounts for nearly 55% of its business. The development of the business is basically determined by car insurance, although agricultural insurance, accident insurance, and health insurance also account for a considerable proportion. The company is also the largest in the property insurance and car insurance market, with a market share as high as 32%. Over the past many years, the company's market share has been equivalent to the sum of Ping An Insurance and China Pacific Insurance.

This performance is currently more of an advantage in terms of being an early mover and having a dominant position. However, it also reflects that the financial innovation level in this industry is not high. Most private insurance companies rely on channel promotion, innovation, and low prices to enter the competition, without advantages in core operational cost management. Therefore, for a long time, the market shares of major property insurance companies have remained stable, without any new growth companies emerging.

However, referring to the experience in the United States, Progressive, with a car insurance ratio as high as 95%, basically has no other type of insurance business and is the most successful insurance company, while other insurance categories are dominated by other insurance leaders.

From this perspective, the business direction of PICC still seems somewhat complex. In other words, there is a problem of insufficient specialization in China's insurance industry.

2. Pros and Cons of New Energy

Currently, the car insurance business is the top priority of the company's business. The penetration rate of new energy vehicles has increased significantly, and it is common for the insurance premiums for new energy vehicles at the same price to be higher than those for fuel vehicles. This seems to be a huge driving force for the development of the car insurance business, but this trend has not been seen in the industry growth rate for the time being.

How to explain this phenomenon? It is not difficult to understand. Although the proportion of new energy vehicle sales is large, the existing stock is very small, only 5%, which contributes little to the growth of the car insurance industry.

On the other hand, is the growth of car insurance premiums always a good thing? Insurance companies do not see it that way. Currently, new energy vehicles are in an immature stage of industry development, with high maintenance costs and high failure rates, leading to high accident and claim rates for new energy vehicles. If claims exceed premiums, it is a loss-making order. It is inevitable that the profit margin of new energy vehicle policies is not as good as that of fuel vehicles at present, leading to hesitation within the industry regarding this growth-driving factor. In other words, some insurance companies are reluctant to issue new energy vehicle policies.

In this situation, it cannot be simply assumed that the development of new energy vehicles will inevitably drive the development of the car insurance industry. However, the increasing number of new energy vehicles is inevitable. Therefore, for property and casualty insurance companies, how to control costs and achieve profits in the new situation is a key capability.

It can be seen that PICC P&C has always maintained a comprehensive cost ratio lower than the industry average. With the same policy, while others do not make money, PICC P&C can earn an additional 2 percentage points. Over time, this accumulates to a difference of hundreds of billions in assets.

Looking globally, companies with the lowest comprehensive cost ratios generally gain long-term competitive advantages. The average comprehensive cost ratio for the entire insurance industry fluctuates around 100%, which aligns with the zero-sum principle of insurance. Most ordinary companies rely on underwriting profits to survive, and then rely on investment income from one year's premium float to maintain company profitability.

Representative US insurance giants Progressive Insurance and Geico Insurance represent two extremes of models. The former has a long-term comprehensive cost ratio lower than the industry average but mediocre investment returns, while the latter does not have a significantly better comprehensive cost ratio than the industry but, due to Buffett's management, can achieve long-term higher investment returns and leading profit margins within the industry.

The current model of PICC P&C is similar to Progressive Insurance. By operating on costs, it has dispelled market concerns about long-term interest rate declines, after all, it does not rely on this advantage. Unlike life insurance companies with a bunch of long-term policies with annualized dividends of 3%+, now that the 30-year national bond rate is only 2.5%, how to make up for the shortfall?

The advantage of the comprehensive cost ratio determines the long-term stability of performance. An average annual profit of 20 billion can surpass the cycle.

This advantage is like the location advantage of hydropower stocks. Having high-quality hydropower stations means low electricity costs, which in the long run can accumulate higher profits

In terms of shortcomings, the company's Achilles' heel is its market share. Currently, there doesn't seem to be much room for upward growth in this share. It can be observed that the company's growth rate has been consistently lagging behind the market, indicating insufficient growth. Compared to the industry benchmark of global insurance, Forward Insurance not only leads in comprehensive cost rates but also manages to expand market share annually, showing excellent long-term premium growth outperforming the industry. Based on this, PICC P&C is obviously weaker in terms of investment value. Don't expect it to have the explosive trend like Forward Insurance. However, as a stable dividend stock, even if it experiences a slow bull market, it's not bad.

III. The Power of Dividend Improvement

For PICC P&C, the value restoration in the Hong Kong stock market is not solely due to its stable business advantages. Business stability and trading below net asset value are not uncommon in the Hong Kong stock market. In recent years, the value restoration is also closely related to the improvement in dividends.

Since 201, the company's profit distribution ratio has been increasing. This year, the idea of distributing dividends twice a year was proposed. Although the current dividend payout ratio is not high compared to many state-owned enterprises at 70%, there is still room for improvement, just passing.

The improvement in the previously low dividend payout ratio is a huge valuation repair driver for undervalued companies. Furthermore, if the future dividend payout ratio can be increased from 50% to 70% or even higher, the bull market journey of PICC P&C will be quite long. Of course, the prerequisite is to maintain the past advantage in comprehensive cost rates. As for growth, it is not necessarily a must.

It should also be noted that the low dividends in the past have a certain degree of performance distortion. As an insurance company, significant profit fluctuations due to natural disasters are normal. However, the company has maintained stable profits over the years. Since the new accounting standards started in 2022, the proportion of investment profits has decreased. It is not difficult to infer that there may have been actions to smooth the profit by using fair value changes in assets accounting methods in the past. Therefore, the past dividend payout ratio of the company may not be as straightforward as it appears However, in terms of absolute numbers, there has indeed been significant progress.

Looking at the profit structure, the investment returns are very high, consistently higher than underwriting profits, which is quite different from American stock property and casualty insurance companies.

This is because the company's investment returns are not just the float investment of premiums for the year, but also a large amount of undistributed profits serving as investment returns for the company's assets. After all, the PB ratio of Foresea Life Insurance is 5 times, so the investment returns generated from such a small net asset value are naturally not significant. On the other hand, the PB ratio of PICC P&C is 0.8 times, with net assets exceeding market value by 25%, so having so much money on hand, it is normal for investment returns to be high.

Naturally, this is not a good thing either, indicating that in the past, not enough was distributed as dividends. The huge net assets are what remains after the 60% of dividends are paid each year. Within the company's current asset structure, there may also be some illiquid assets that could see a significant markdown in value.

With the background of long-term declining interest rates, the expected investment returns are bound to deteriorate. Therefore, for the company, the key to transitioning from a slow bull market to a major bull market is: increasing the dividend payout ratio each year. Secondly, addressing the issue of lower investment returns, beyond the profits for the year, using the cash on the balance sheet as a basis for excess repurchases or special dividends to simplify the asset-liability structure. If these two points can be achieved, PICC P&C has the potential to become a benchmark for stable dividend-paying stocks in the Hong Kong stock market, with significant room for upside.

IV. Conclusion

Despite still being below book value, PICC P&C currently presents very good investment value. It may not become China's PGR, with a 10x return in 10 years, but it is indeed a unique target in the entire financial industry.

Buffett's core financial stock holding is Geico Insurance, which has been privatized. He has also expressed his fondness for the property and casualty insurance business model on multiple occasions. His thinking and viewpoints are definitely long-term, looking at returns over decades. PICC P&C is a target that closely aligns with this kind of thinking.

As mentioned above, for this company to become a major growth stock, two improvements are needed. However, if these do not materialize, a conservative expectation for PICC P&C would be to outperform the index each year and achieve positive returns, which is quite reasonable