ESS-Life

Research

FOR IMPORTANT DISCLOSURE INFORMATION, INCLUDING DISCLOSURES RELATED TO THE U.S. DISTRIBUTOR OF THIS REPORT, PLEASE REFER TO THE FINAL PAGES OF THIS REPORT - Please refer to the final pages of this report for important disclosures, analyst certifications and additional information. Espirito Santo Investment Bank does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. This research report has been prepared in whole or in part by research analysts based outside the US who are not registered/qualified as research analysts with FINRA (v1.0.5.2)

FUNDAMENTAL INSIGHT

India | Insurance | 5-June-2014

India Life Insurance

Coming back to Life

The life insurance sector is slowly but surely turning a corner after

four difficult years as the outlook for the economy improves and

most of the destabilizing regulatory changes are now behind it. Our

analysis points to margins bottoming out in H1FY15 and improving

from there. With the top players sitting on capital surpluses and

enjoying significant operating leverage, we expect RoEVs of large

insurance players to reach 15% in the next three years. Another big

potential trigger is the Insurance Amendment Bill. Max Life, ICICI

Life and HDFC Life remain the top companies in this space. We

remain BUYers of Max India, Reliance Capital and Bajaj Finserv. Max

India remains our top BUY.

On the verge of a turnaround

Over the past four years the insurance industry was in a state of flux as it was

buffeted by several headwinds — regulatory shift, deteriorating distribution

structure, weak macro environment and declining savings rate. However, we

think most of the sector’s troubles are now in its rear-view mirror and the

industry is now on the verge of a turnaround and see substantial value in it.

Growth is coming back: Our interaction with insurers indicates new business

premium growth after many years, driven by a general optimism about the

economy and equity markets kicking into growth mode. Also, with most of the

regulations on products now over we expect some regulatory stability and

certainty, at least on the product structuring side. We expect the industry to

grow at 5%-10% in FY15 and then register c.15% growth rate for the next few

years. The life insurance sector has a strong correlation with the savings rate

and if the savings rate were to grow then the sector could see stronger

growth rates.

Increasing shareholder value creation: We see shareholder value creation

getting a boost — a) with traditional product guidelines already in place we

expect margins to bottom out in H1FY15 and then as companies arrive at an

optimal product mix and engage in more active investment management we

see margins improving; and b) there is significant operating leverage in the

system and with the economy in revival mode we see both growth and

persistency improving, which will have a significant impact on over-runs

leading to increased RoEV. We expect most of the large life insurance

companies to move to c.15% RoEV in the next three years, with Max, HDFC

and ICICI registering RoEVs above that.

Insurance Bill can be a big trigger: If the insurance bill were to be passed in

the parliament with 49% FDI then it could be a big positive catalyst for

insurance-related stocks as this could push more insurance entities to go for

primary market listings, thereby providing better valuation benchmarks and

attract investor attention to the sector. Also it would help capital starved

smaller companies access capital more easily.

Recommendation – Positive on the sector

A recovering economy and regulatory certainty augur well for the life

insurance industry. Despite life insurance stocks moving up (50% YTD vs

Sensex 35%) we remain buyers of Max India (new FV of Rs405 from Rs308),

Reliance Capital (new FV of Rs692 from Rs592), and Bajaj Finserv (new FV of

Rs1027 from Rs868) as we believe there is more upside left. .

Max India

BUY 24% upside

Fair Value Rs405.00

Bloomberg ticker MAX IN

Share Price Rs326.00

Market Capitalisation Rs86,695.00m

Free Float 65%

Bajaj Finserv

BUY 12% upside

Fair Value Rs1,027.00

Bloomberg ticker BJFIN IN



Free Float 41%

Reliance Capital

BUY 11% upside

Fair Value Rs692.00

Bloomberg ticker RCAPT IN



Free Float 50%

Source: Espirito Santo Investment Bank Research, Company

Data, Bloomberg

Analysts Santosh Singh, CFA +91 22 43156822 [email protected] Espirito Santo Securities India Private Limited Nidhesh Jain +91 22 4315 6823 [email protected] Espirito Santo Securities India Private Limited

Why should you read this note?

For our analysis on why the Indian Life

Insurance industry is set to enter a

growth phase and micro-level analysis

of seven companies discussed in the

report

Page 1 of 47

Page 2 of 27

The industry has been through a tough

transformational phase as changing

regulatory winds and unfavourable

macro environment buffeted it.

Looking back before we look ahead

Before we look ahead, we think it’s important to look back at the past four

years to see the path the industry has traversed through. The past four years

have been transformational years for the industry, with many life insurers

forced to change their business model to adapt to the regulatory changes.

This period is significant from the regulatory activism point of view — the

regulator came out with pro customer regulations which we believe has

spurred structural changes within the industry. Key regulations were the unit-

linked guidelines brought out in October 2010 and the traditional product

guidelines effective 1 January 2014. In our opinion these regulations were

required but the speed and timing of this can be deliberated. The problems of

the industry were exacerbated by the fact that this was the period of weak

equity markets and a slowing economy. Following are the key highlights of the

past four years.

New business premiums declined: Over the past four years new business

premiums declined by 25% for the sector from the highs in 2011 (see chart

below), driven by the change in regulations and the general slowdown in

the economy.

Figure 1 Total new business premium has stabilised in 2014… Figure 2 …however private sector premiums continue to decline

Source: Espirito Santo Investment Bank Research, Company Data Source: Espirito Santo Investment Bank Research, Company Data

Product mix changed substantially: During the past four years the

product profile in India has changed substantially. At one point in time the

market was dominated by unit-linked products, accounting for 80% of the

private market but now it accounts for just 30% of the private market.

Now the traditional products led by par products (see Figure 3&4) are in

demand.

Figure 3 ICICI Prudential Life Product Mix Figure 4 HDFC SL product mix


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Page 2 of 47

Page 3 of 27

Figure 5 First Year Premium (private sector) Figure 6 First year premium (private sector) break-up


Distribution mix changed substantially: As the unit-linked guidelines

reduced the life insurer’s ability to pay intermediaries the distribution mix

changed significantly. The proportion of agency has declined substantially

over the past four years and now accounts for less than 40% of the total

sales of the top-7 private players. Bancassurance became the core

channel to sell products and increased its market share to 47%. Going

forward we think that the agency channel will start picking up again (with

the impact of regulations fading off) and regain some of its lost market

share.

Figure 7 Distribution share of bancassurance has increased… Figure 8 …for the top-7 private players


Margins declined substantially: As a result of all these changes and the

changing product mix, the margins in the system have been declining and

now have moved down by almost 400-500bps over the past four years.

FY14 margins are an aberration (as for the first 6 months of FY14 the

companies were able to sell high margin products) and we expect the

margins to decline further by 2%-6% in FY15 (given the new product

guidelines) which should see margins bottoming out for life insurance

companies.

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Micro Agents Direct Business Referral

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Page 3 of 47

Page 4 of 27

Figure 9 VNB margins for Max Life Figure 10 VNB margins for HDFC Life


Figure 11 VNB margins for Reliance Life Figure 12 VNB margins for Bajaj Allianz Life


Companies became profitable both on EV and cash: Majority of the life

insurance companies were incurring losses for the first 10 years of

business, which led to a need for regular capital infusion. Also, majority of

the companies were not registering any growth in embedded value (EV)

on an organic basis (i.e. without capital infusion). However, over the past

four years as companies focused on reining in costs we have seen most of

the companies starting to make profits. Also, surrender of past ULIP

policies helped boost the profits of some companies substantially. High

quality companies like Max and HDFC started showing significant growth

in EV on an organic basis. Given that there was no growth and the

companies were generating excess cash a lot of the life insurance

companies started paying dividends.

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Page 4 of 47

Page 5 of 27

Figure 13 EV growth excluding dividend Figure 14 Statutory PAT


Better days ahead?

The last four years have been tough for the life insurance industry with

companies facing myriad challenges — a) the weak equity markets, b) decline

in savings rates, c) regulatory shift which drove a structural change in the

industry and d) increased criticism and scrutiny of the life insurance industry

by the media and public. However, a lot seems to be changing with a) equity

markets starting to perform, b) outlook for the economy brightening, c)

regulations on products over and we expect more regulatory clarity from here

on and d) insurance companies working hard to make the products customer

friendly. Hence we can expect the industry to do well over the next few years.

Regulatory: Regulations are part and parcel of the financial sector and we see

them evolving over time; however the regulatory activism of the past four

years is unlikely in the near future. Following are the key areas where we

expect some regulatory changes over years.

Regulations around Bancassurance: This is one long awaited regulation

by industry players and market participants. The current draft suggests

banks may be allowed to work as brokers. However, if the regulations

were to be implemented in the form as suggested in the draft (refer to

figure below) we do not think a lot of banks will turn into brokers in the

near term given that a lot of them either have binding agreements with an

insurance company or they hold significant stake in life insurance

companies. However, there were news flows (LINK) around the

government and the regulator (IRDA) forcing the banks to become

brokers. In our view it makes sense for the sector to have an open

architecture of distribution; however, it needs to be done in a manner

which is less disruptive. We believe open architecture is the way forward

and it will be positive for the sector if the regulator acts in a calibrated

fashion.

Figure 15 Regulatory guidelines on banks acting as brokers

Date Guidelines

Aug-13

IRDA issued final guidelines on Banks acting as Insurance Brokers

Banks can act as brokers for distribution of insurance products after securing an Insurance Broking license from IRDA.

Not more than 50% of the business for a bank acting as Insurance broker shall come from a single client.

Not more than 25% of the business for a bank acting as Insurance broker shall come from insurance companies within the

promoter group.

Nov-13

RBI issued draft guidelines for banks undertaking Insurance broking business.

Banks' net worth>Rs5bn, CRAR>10%, NNPA<3%.

Bank should be profitable for the last three years and performance of subsidiaries/JVs should be satisfactory.

Banks acting as Insurance brokers cannot act as corporate agents or refer customers for insurance either departmentally

or through subsidiaries/group companies.

Source: Espirito Santo Investment Bank Research, Company Data

(2,000)

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Max Bajaj HDFC Birla

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in R

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2012 2013 2014

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ICICI Pru HDFC SL BAJAJ SBI MAX

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AT

(In

Rs M

n)

Page 5 of 47

http://www.business-standard.com/article/finance/irda-may-ask-all-banks-to-become-insurance-brokers-114011700003_1.html

Page 6 of 27

Insurance amendment bill: This is a key piece of regulation (see figure

below for key features) pending in the parliament for the last many years.

Now with a new government with absolute majority at the helm we

expect this bill to go through in the parliament in the near term. The

Insurance Amendment Bill if passed could be a significant positive for

insurance companies as it will open up the sector for IPOs and foreign

investors. On a fundamental basis we do not think the larger life insurance

companies need capital in the near term to grow (refer table 39-41 on

page 12) however it will provide investors clarity on valuation benchmarks

and we may also see a lot more standardization in the way life insurance

companies report. This could be most helpful for smaller life insurance

companies that are starved for capital and also from an M&A perspective

we think the insurance industry in its current form is unsustainable and

some amount of consolidation is inevitable for healthy growth of the

industry.

Figure 16 Insurance Amendment Bill 2008

Key highlights of Insurance Amendment Bill

Definition of Indian Insurance Company (which defines the extent of foreign ownership) changed to allow 49% FDI in Insurance.

Health Insurance business to be recognized as a separate line of business.

Minimum Capital requirement for health insurance and re-insurance companies operating in India increased to Rs1bn.

Recognition of Tier-II capital for Insurers.

Liberalization of restrictions on sanctions of loans and advances by insurers.

Minimum business in third party risks for motor vehicles for general insurance companies.

Recognition of partial assignments of insurance policies.

Vesting powers with IRDA on prescribing ceilings, payment of commission on orphan policies and fixing ceilings on expenses

of management.

Dispensing with the process of licensing of agents and entrusting responsibility of appointing of agents to insurers.

Payment of renewal commissions after termination of agents.

Fixing timelines for denial of claims by insurers on grounds of misstatements etc.

Substantial increase in penalties for violations.

Source: Espirito Santo Investment Bank Research

DTC: This is the much awaited regulation around tax reforms. DTC in its

current form suggests that the tax rate for life insurance companies

should be increased from the current levels of 12.5% to a normal rate of

c.30%. This in our view could be negative for life insurance companies;

however the house panel (led by BJP) talked about a 15% tax rate which

in our opinion could be the way forward.

Figure 17 Direct tax code and House panel recommendations

Direct tax code House Panel recommendations

1 Applicable tax rate for life insurance companies to

increase to 30% from 12.5%.

Applicable tax rate for life insurance companies to

increase to 15% from 12.5%.

2

Sum insured should be at least 20x annual premium

from the current 10x for policy holder to claim tax

benefit.

No Change

3

5% distribution tax on income to policyholders of a

scheme with investments in excess of 65% in

equities.

Insurance policy dividends should be exempted from

dividend distribution tax.


Sector is dependent on the economy: Given the nature of the insurance

products, which are more of savings in nature, the new business flows as well

as persistency of the policies are a lot geared towards the economy. We see a

clear correlation between the GDP growth, savings rate and penetration of life

insurance. Also, across geographies we have seen that the persistency of the

policies is correlated with the performance of the markets.

Page 6 of 47

Page 7 of 27

Figure 18 Insurance premiums are highly correlated with savings rates


Hence, with the expectation of the improvement in economy we can see

savings rate as well as new business premiums going up. Also, we may see the

persistency of policies improving.

Margins may bottom out in H1 2015: With the new product guidelines in place

most life insurance companies have seen a significant decline in margins since

2010. However, margins may have bottomed in Q4 as it was one of the most

difficult quarters given a) this was the transitional quarter from old products

to new products, b) economy was weak and c) significant redemption

pressure from old ULIPs. However, going forward we may see some

improvement in margins mainly from FY16 given

a) Operating leverage starting to play out: We expect the economy to

improve leading to higher new business premiums. As is visible from our

analysis below the life insurance companies have very high operating

leverage given that a vast proportion of their costs are fixed.

Figure 19 Operating cost analysis for top-7 life insurers (FY14)

% of total cost Max Life HDFC Life Birla

Sunlife

Bajaj

Allianz*

Reliance

Life

ICICI

PruLife SBI Life

Investing for future growth 14% 14% 13% 25% 26% 10% 15%

Cost for new business acquisition in current year

63% 59% 63% 55% 54% 63% 60%

Cost of servicing existing business 23% 27% 24% 19% 20% 26% 25%

Cost as % of AUM Max Life HDFC Life Birla

Sunlife

Bajaj

Allianz*

Reliance

Life

ICICI

PruLife SBI Life

Investing for future growth 0.8% 0.4% 0.6% 1.2% 2.2% 0.2% 0.3%


3.6% 1.7% 2.8% 2.7% 4.4% 1.4% 1.4%

Cost of servicing existing business 1.3% 0.8% 1.0% 0.9% 1.6% 0.6% 0.6%

Cost as % of NBP Max Life HDFC Life Birla

Sunlife

Bajaj

Allianz*

Reliance

Life

ICICI

PruLife SBI Life



35.2% 20.6% 38.5% 29.5% 38.5% 27.2% 14.4%


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Page 7 of 47

Page 8 of 27

Figure 19 Operating cost analysis for top-7 life insurers (FY14)

Cost as % of Total Premium Max Life HDFC Life Birla

Sunlife

Bajaj

Allianz*

Reliance

Life

ICICI

PruLife SBI Life



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Source: Espirito Santo Investment Bank Research, Company Data, * FY13 numbers

Figure 20 Operating cost analysis by products for Life Insurance companies


b) product structure should start evolving: Uncertainty around regulations

and weak equity markets meant that the products structure for

companies started to get dominated by par policies, given that par

policies have low margins but a) have little or no strain on cash flow and

also are b) highly capital efficient. However with capital not a problem

(see figures 33 to 38 for solvency margins of top players) for large

insurance companies and regulatory certainty we expect some of the

large insurance companies to start changing their business mix over the

next few years. We would expect higher sales of non-par products, higher

mix of protection and even health-related product sales to pick up. This

should mean that we may see some improvement in margins over the

next couple of years

Figure 21 Max Life VNB margins Figure 22 Bajaj Allianz Figure 23 HDFC Standard Life

Source: Espirito Santo Investment Bank Research, Company Data Source: Espirito Santo Investment Bank Research, Company Data Source: Espirito Santo Investment Bank Research, Company Data

Figure 24 Birla SunLife Figure 25 Reliance Life


2012 2013 2014 2012 2013 2014 2012 2013 2014Cost recovery

Driver

Shareholders'

surplus Driver

% of NBP 79% 79% 75% 44% 62% 0% 21% 53% 114%

% of Total Premium 32% 25% 21% 27% 25% 0% 11% 15% 32%

% of AUM 25% 17% 12% 18% 15% 0% 3% 3% 6%

% of NBP 46% 52% 47% 11% 19% 0% 54% 53% 65%

% of Total Premium 21% 22% 14% 5% 8% 0% 30% 26% 12%

% of AUM 25% 23% 10% 4% 6% 0% 27% 21% 6%

% of NBP 103% 118% 55% 350% 338% 0% 64% 45% 42%

% of Total Premium 7% 8% 10% 19% 34% 0% 12% 12% 11%

% of AUM 2% 2% 2% 3% 3% 0% 2% 2% 2%

Comments

Acquistion costs and other operating costs

are recovered through premium payments.

Shareholders' surplus is driven by return on

AUM

Acquistion costs and other operating costs

are recovered through premium payments.

Shareholders' surplus is driven by return

(higher than guaranteed) on AUM

Acquistion cost, other operating costs and

shareholders' surplus is driven by AUM

Comments

First year and

subsequent year

premiums

Returns generated

on policyholders'

AUM

First year and

subsequent year

premiums

Returns (higher

than guaranteed)

generated on

policyholders' AUM

AUM AUM

Bajaj Allianz ICICI Pru

Par

Non

Participating

Linked

business

Operating

expenses

Max Life

11.0%

11.2%

11.4%

11.6%

11.8%

12.0%

12.2%

12.4%

12.6%

2015E 2016E 2017E 2018E

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B M

arg

ins

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11%

11%

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2015E 2016E 2017E 2018E

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2015E 2016E 2017E 2018E

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2015E 2016E 2017E 2018E

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Page 8 of 47

Page 9 of 27

c) More active management of investments: This is one area of life

insurance where the insurance companies have invested the least.

Companies till now have been very risk averse and have also not looked at

the value proposition being offered to the customers. However, with all

the arbitrages now blocked by the regulator, if an insurance company

wants to increase its margins within products then they will have to look

at generating more returns for customers specifically in par and non-par

structures (see table below for illustration).

Figure 26 Impact of investment returns on EV (Max Life FY14 disclosures)


Upside from persistency: One of the key ingredients while calculating margins

of the life insurance company is persistency, in our previous note (LINK) we

had highlighted what caused the reduction in persistency amongst Indian

insurance companies. We think there could be an upside on this front as

various roadblocks that hindered persistency have been addressed or are in

the process of being addressed.

Mis-selling: IRDA’s efforts over the past 5 years and companies focus

on this aspect have helped, with definite improvement compared to

the past.

Poor product performance: This was also driven by mis-selling and

the performance of equity markets. Customers were losing money

even after couple of years of investments. We think that with the

market starting to hold up and mis-selling reducing there could be

some upside on this metric as well.

Changes in product structure: There were frequent changes in

product structure over the past four years by IRDA, which caused

some amount of lapsation. Now with the expectation of product

structure stabilizing, things may be changing for good for life

insurance companies

Economic environment: This plays a really important part in

persistency of policies. Our analysis of global persistency suggests

there is a strong correlation between the economic environment and

persistency (see charts below). With improvement in the economic

environment we expect persistency to improve.

2.3%

-2.4%

7.7%

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-6.0%

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Investment Return + 100bps Investment Return - 100bps

Value of In force Value of New Business

Page 9 of 47

http://publication.espiritosantoib.co.in/Get.aspx?ID=a8299d18-e3c9-4d33-8eb8-78451f77dbad

Page 10 of 27

Figure 27 Persistency in lead life insurance geographies Figure 28 Historical persistency in Japan

Source: Espirito Santo Investment Bank Research Source: Espirito Santo Investment Bank Research

Figure 29 Historical persistency in UK Figure 30 Historical persistency in US Figure 31 Historical persistency for LIC

Source: Espirito Santo Investment Bank Research Source: Espirito Santo Investment Bank Research Source: Espirito Santo Investment Bank Research

This could be the single most important factor that could drive the

profitability of life insurance companies and move up margins. More so in the

current environment when the surrender charges on policies have been

capped and the company can make higher margins only if it is able to retain

its customers for a longer duration.

Renewal and inflow growth: Over the past three year’s renewal premiums as

well as net inflows for life insurance companies were declining. This was on

account of a) new business premiums declining, b) persistency deteriorating

and c) considerable redemption pressure on old ULIP policies.

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Persistency improved as

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Persistency declined in periods of

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economic uncertainty Persistency declined in periods of

economic uncertainty


economic uncertainty and as

competition increased

Page 10 of 47

Page 11 of 27

Figure 32 Renewal premiums for leading private life insurance companies in India


However going forward we may see renewal premiums as well as net inflows

growing for life insurance companies as a) new business premiums should

start growing, b) persistency starts improving and c) majority of the old ULIP

policies have already been redeemed.

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2006 2007 2008 2009 2010 2011 2012 2013 2014

23% 25% 12% -12% 20% 0% 11%CAGR (09-14)

Page 11 of 47

Page 12 of 27

Capital Position looks strong

Over the past few years the capital position of the companies have been

strengthened, mainly driven by three factors:

a) Companies getting profitable on statutory basis

b) Slower growth in AUM and new business premiums

c) Increase in composition of par portfolio, where companies can to an

extent even utilize policyholder money as capital

Figure 33 HDFC SL solvency ratio Figure 34 Birla Figure 35 Max Life


Figure 36 Bajaj Figure 37 Reliance Figure 38 ICICI Pru


Figure 39 Solvency capital calculations for Max Life

Max Life 2009 2010 2011 2012 2013 2014

(01) Available Assets in Policyholders' Fund: 50,385 92,908 125,163 150,254 183,260 225,349

Deduct:

(02) Mathematical Reserves 49,854 91,711 122,731 146,594 174,848 216,523

(03) Other Liabilities 1,195 (3)

(04) Excess in Policyholders' funds (01)-(02)-(03) 531 1,197 2,432 3,660 7,217 8,829

(05) Available Assets in Shareholders Fund: 11,224 14,490 20,735 30,650 33,529 34,007

Deduct: 0 0 - - -

(06) Other Liabilities of shareholders’ fund 5,732 7,145 10,881 13,355 15,889 13,226

(07) Excess in Shareholders' funds (05)-(06) 5,492 7,345 9,854 17,294 17,640 20,781

(08) Total ASM (04)+(07) 6,023 8,542 12,287 20,954 24,856 29,610

(09) Total RSM 1,981 2,657 3,367 3,924 4,773 6,106

(10) Solvency Ratio (ASM/RSM) 3.0 3.2 3.7 5.3 5.2 4.9


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Page 12 of 47

Page 13 of 27

Figure 40 Solvency capital calculations for HDFC Life

HDFC Life 2011 2012 2013 2014

(01) Available Assets in Policyholders' Fund: 257,921 312,200 387,241 487,042

Deduct:

(02) Mathematical Reserves 256,465 308,910 377,720 485,470

(03) Other Liabilities - 1,053 5,384 -

(04) Excess in Policyholders' funds (01)-(02)-(03) 1,457 2,237 4,136 1,571

(05) Available Assets in Shareholders Fund: 6,423 9,102 13,588 19,275

Deduct:

(06) Other Liabilities of shareholders’ fund - - 0 -

(07) Excess in Shareholders' funds (05)-(06) 6,423 9,102 13,588 19,275

(08) Total ASM (04)+(07) 7,879 11,339 17,724 20,846

(09) Total RSM 4,571 6,025 8,152 10,751

(10) Solvency Ratio (ASM/RSM) 1.7 1.9 2.2 1.9


Figure 41 Solvency capital calculations for Birla Life

Birla Life 2011 2012 2013 2014

(01) Available Assets in Policyholders' Fund: 190,854 201,221 217,592 236,567

Deduct:

(02) Mathematical Reserves 185,201 195,683 213,671 234,801

(03) Other Liabilities 0 (2) 4 41

(04) Excess in Policyholders' funds (01)-(02)-(03) 5,653 5,539 3,925 1,726

(05) Available Assets in Shareholders Fund: 5,524 7,756 9,353 8,602

Deduct: - - - -

(06) Other Liabilities of shareholders’ fund - - - -

(07) Excess in Shareholders' funds (05)-(06) 5,524 7,756 9,353 8,602

(08) Total ASM (04)+(07) 11,177 13,295 13,278 10,328

(09) Total RSM 3,871 4,446 4,965 5,540

(10) Solvency Ratio (ASM/RSM) 2.9 3.0 2.7 1.9


Hence, although we do not expect capital infusion in any of the life insurance

companies, we would just like to highlight that in absolute terms these

surpluses are not really high and if some of the companies keep paying

everything they generate as surplus as dividends to shareholders, then we

may see solvency levels decline significantly as the new business strains will

mean that the company may need to strengthen their Balance Sheets.

Statutory profit may not grow sharply

Statutory profits grew so sharply between 2010 and 2013 for some of the life

insurance companies due to a) accumulated surrenders in their book and also

b) for last few years new business premiums were declining, leading to lower

strain on new business. However with the expectations of growth, cap on

surrenders and existing book of Funds for Future appropriation declining we

expect reduction/muted growth in profitability for these life insurance

companies. However PAT growth will be different for different companies

Max and HDFC may be the best placed company on this metric given they

have been able to manage their persistency better than others and also they

were not the biggest beneficiaries of surrenders in the past.

Page 13 of 47

Page 14 of 27

Figure 42 Max Life PAT Figure 43 Bajaj Life PAT Figure 44 Reliance PAT


EV growth rate may improve

Most of the companies, barring Max Life and HDFC Life, were incurring high

cost overruns and hence EV growth was disappointing. However, if the new

business premium growth rate were to pick up for the industry we expect a lot

companies breaking even on cost over the next four years. Also, if the

persistency of companies were to improve from here (as discussed on page 9)

we may see the variance reducing. We would expect most of the large

companies to generate c.15% RoEV over the next three years, with the leaders

being Max and HDFC Life (for whom we expect the ROEV to be more around

20%).

Figure 45 Max Life (CAGR of 14% over 2010-2014) Figure 46 Bajaj Allianz (CAGR of 6% over 2011-2014)


Figure 47 HDFC Life (CAGR of 20% over 2010-2014) Figure 48 Birla Sun Life (CAGR of 3% over 2010-2013)


-

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Page 14 of 47

Page 15 of 27

Performance of companies on different parameters

On the quantitative parameters a lot of Indian insurance companies may have

not done that well, however qualitatively we have tried to compare the

various insurance companies

Persistency

We have been talking about this as one of the key variable to measure when

we one compares life insurance companies. If we see the recent development

in persistency we can see that HDFC Life and Max India are at the top. Higher

persistency gives a sense of the quality of the business and the company’s

focus on retaining customers.

The impact of higher persistency is clearly visible from the fact that HDFC, SBI

and Max have the highest growth in renewal premiums.

Figure 49 13th

month Persistency of life insurers Figure 50 49th

month persistency for life insurers


Table 51 Relative positioning of Life Insurers

ICICI

Prudential

SBI life

Insurance Bajaj Allianz Max Life

HDFC

Standard life Reliance life Birla Sunlife

Persistency

Source: Espirito Santo Investment Bank; full green coloured circle = best, full white = worst

Distribution

This is the backbone of the life insurance industry. As explained earlier in the

note the life insurance industry has moved from agency-dominated

distribution model to banks-dominated distribution over the past four years;

however, we think the key for success of a life insurance company is a

multichannel approach as each channel has its own strengths. ICICI Prudential

Life, SBI Life and Max Life score well on this metric.

40%

50%

60%

70%

80%

90%

100%

200520062007 20082009 2010 2011 2012 2013 2014

13th

Mo

nth

Pe

rsis

ten

cy

Bajaj Allianz Max Life Reliance Life

ICICI Pru SBI Life HDFC SL

Persistency declined

due to economic

uncertainity

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2008 2009 2010 2011 2012 2013 2014

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Bajaj Allianz Max Life Reliance Life

ICICI Pru SBI Life HDFC SL

Persistency declined due

to ULIP book for pre-

2010 completed three

years.

Page 15 of 47

Page 16 of 27

Figure 52 Distribution Mix for Life Insurers (2014)



ICICI

Prudential

SBI life


HDFC


Distribution


Operating expenses

This is another key metric as cost overruns have been one of the key problems

for the industry. Again ICICI, HDFC and Max compare favourably on this metric

with Max and ICICI being the only two companies not showing overruns

amongst the companies who provide EV disclosure.

Figure 54 Opex as % of FUM (FY14) Figure 55 Opex as % of APE (FY14)


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Agency Banks Corporate Agents

Brokers Micro Agents Direct Business

Referral

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Page 16 of 47

Page 17 of 27

Figure 56 Opex as % of NBP Figure 57 Opex as % of total premium



ICICI

Prudential

SBI life


HDFC


Operating expense


M&A within the sector

There has been a lot of news flow (LINK) around the consolidation in the

sector in the past. Below we discuss the M&A opportunity:

Figure 59 Recent M&A deals in Indian Life Insurance space


Figure 60 Deals in the news in Indian Life Insurance sector


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SunLife

Bajaj

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Life

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To

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Pre

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m

Company Seller Buyer % stake sold Valuat ion Date Comments

Max Life NewYork Life Mitsui Somitomo 26%10,500 (2.5x

EV)Jun-12

Foreign partner exited as per their st rategy of

concentrat ing on business in local geography

Reliance Life Reliance Capital Nippon Life 26%11,500

(3.3x EV) Mar-11

Nippon Life entered Indian Life Insurance

sector through Reliance Life

MetLife Met Life Punjab Nat ional Bank 30% Sep-12PNB provides a st rong bancassurance

partner

ING LifeING Group, Hemendra Kothari

Group, Enam GroupExide Industries Ltd. 50% 1,100 Jan-13 Sellers wanted to exit the Insurance venture

Company Promoters Strengths AUM (FY13) NBP PAT Comments Outcome

Aviva India Aviva PLC, Burman Family

Strong bancassurance

partner (Indus Ind Bank),

Agency network

Rs71bn Rs6.8bn Rs0.3 Aviva wants to exit St ill in process

Canara HSBC Canara Bank, HSBC, OBC Bancassurance partners Rs60bn Rs6bn Rs0.2 HSBC wanted to sell its stake in the ventureCanara bank and OBC

opposed the stake sell

Page 17 of 47

http://timesofindia.indiatimes.com/business/india-business/Consolidation-seen-in-life-insurance/articleshow/7783537.cms?referral=PM

Page 18 of 27

Uncertainty on FDI has acted as a catalyst

Many companies invested in the sector over the past 14 years based on the

assumption that FDI in the sector will increase from 26% as a 26% stake for a

lot of large companies in small Indian ventures were miniscule. The bigger

problem was in ventures where the foreign partner was willing to put money,

however the Indian partner was not interested in investing further in the life

insurance venture, this led to subscale business as the foreign partner could

not infuse the capital needed for growth. We think this disappointment was a

reason why some foreign partners left or are trying to leave the Indian

markets.

Promoters’ expectations were different

The Life insurance companies entered this sector in two phases (see chart

below), however in our opinion the expectations of the promoters who

entered in 2008-9 were a little bit stretched given that they entered looking at

the fast growth and the type of valuation which these ventures were getting

then. However, that situation has totally changed over the past four years and

hence some of these promoters are finding that their JVs are subscale and

they do not have either the ability or the willingness to infuse capital in these

ventures.

Figure 61 Various times at which life insurance companies entered the sector


Insurance companies are in totally different phases of growth

One of the other reasons that support a consolidation within the sector is the

different phase of evolution each companies are in.

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450

2001

(4)

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(11)

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ICICI,

Max,

Birla.

ING

Kotak

Bajaj

TATA

SBI

MetLife

Reliance

Aviva

Sahara

Shriram

Bharti

Future

IDBI

Canara

DLF

Star

Religare

IndiaFirst

Edelweiss

Page 18 of 47

Page 19 of 27

Figure 62 Top-7 players are profitable… Figure 63 …and adequately capitalised


Will it happen?

However the bigger question is, are we going to see frequent M&As in the life

insurance sector? Unlikely in our view as

The vast chasm between what sellers want and what buyers are willing to

pay: The couple of deals in the life insurance industry (which were closed at 3x

EV) has set the benchmark for valuation. However we think the idea of an

Indian insurance company buying another Indian life insurance at similar

valuation (ie, at 3x EV) is too farfetched as the value accretion from any

merger or acquisition is limited for an Indian insurer. Complicating things

further is the difference in the quality of the books among life insurance

companies. An Indian insurer may be willing to pay some discount to EV for

the book, but the premium over EV is totally dependent on the value accretion

which can happen mainly through distribution as most of the other

infrastructure is overlapping to a vast extent. Hence, there have been gaps

between the expectation of the buyer and the seller. This has is one of the key

reasons why we have not seen many deals happening in the past.

FDI cap a constraint: With a FDI cap of 26%, foreign companies are now less

enthusiastic to enter the space/ buy stakes in Indian entities as they have seen

that their Indian partners have failed to pull their weight (having stopped

contributing to life insurance companies that badly needed capital).

Regulatory: IRDA is yet to come out with a clear set of M&A guidelines in the

sector and with Indian life insurance companies not allowed to hold partial

stake in each other this is a big challenge for M&A to happen within the sector.

India insurers VS Global Insurance companies

Although Indian insurance companies are at a totally different stage of growth

compared with their Asian peers, we believe a comparison between the two is

warranted to give investors a look at the relative positioning of the life

insurance companies.

Margins: Most of the bigger Asian life insurance companies enjoy higher

margins than their Indian counterparts. A key reason for this is we believe the

product profile of Indian insurance companies (which are dominated by

savings products).

-

2,000

4,000

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8,000

10,000

12,000

14,000

16,000

ICICI Pru HDFC SL BAJAJ SBI MAX

FY

13 P

AT

(In

Rs M

n)

0%

20%

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60%

80%

100%

120%

140%

160%

180%

200%

ICICI BAJAJ IFFCO HDFC ERGO TATA AIG

So

lve

ncy

Marg

in

Page 19 of 47

Page 20 of 27

Figure 66 Risk discount rates

Discount Rates

AIA 7.75%-19.0%

China Life 11.50%

Ping An 11%

Aviva 7.50%

Axa 7.00%


Figure 64 VNB (2013) Figure 65 RoEV (2013)


Growth: Although Indian life insurance companies have experienced muted

growth over the past three years we would be expect the growth rate for the

Indian markets to be in excess of most of the economies going forward given

all the drivers that can drive life insurance are present in India. We would

expect the life insurance industry to show c.5%-10% growth rate for FY15.

RoEV: Despite one of the lowest margins globally Indian companies have one

of the highest ROEVs as the capital requirements have been lower and also

the companies have been making losses for the last many years (which has

meant that the net worth has also deteriorated). One more reason for the

higher RoEVs of Indian firms could be the discount rate they use for margin

calculation, which is one of the highest globally (see table).

Leverage: We have measured the leverage of Insurance companies based on

FUM/EV, which identifies the quality of the book and riskiness. It is clearly evident

that the FUM/EV is one of the lowest for the Indian insurance companies despite

underwriting low margin products implying low risk and higher profitability.

Figure 67 FUM/EV showing leverage of different players Figure 68 EV profit/ FUM of different players


0%

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Page 20 of 47

Page 21 of 27

Valuation of life insurance ventures

Table 19 Relative valuation of Life Insurers

Implied Market

Value ($ mn) P/EV P/VNB P/FUM FY14E RoEV

Indian Life Insurers

Reliance Life 1,224 2.3 24.6 0.43 11%

Birla Sun Life 1,212 1.8 33.6 0.31 10%

Bajaj Allianz 1,868 1.5 74.5 0.33 12%

Max Life 1,574 2.4 38.9 0.43 16%

HDFC Life 2,144 1.8 19.3 0.26 18%

Implied Market

Value ($ mn) P/EV P/VNB P/FUM

EV growth

(2013)

Foreign Insurance Players

AIA 61,234 1.8 41.1 0.51 10%

China Life 77,108 1.4 22.6 0.26 1%

Ping An 51,467 1.7 17.7 0.31 14%

Samsung Life 19,085 0.8 17.0 0.13 5%

Aviva* 25,818 1.2 18.5 0.06 5%

Axa* 58,932 1.0 20.3 0.11 8%

Prudential* 58,670 1.5 12.4 0.12 11%

Standard Life* 15,629 1.1 29.2 0.04 3%

Allianz* 76,891 3.0 59.4 0.12 12%

Source: IRDA, Espirito Santo Investment Bank, ** Our numbers for Reliance Life, *Also includes other businesses

Relative positioning of life insurance companies

We analyse life insurance companies on various parameters including

distribution product mix, persistency and conclude that Max Life and HDFC

Life are at the top on most of the metrics.

Page 21 of 47

Page 22 of 27

Table 16 Relative positioning of Life Insurance companies

ICICI

Prudential

SBI life


HDFC


Distribution

Product Mix

Expense ratio

Persistency

Agents’ productivity

Cash flow trends

EV growth


Page 22 of 47

Page 23 of 27

Annexure -1

Figure 69 Explanation of cost analysis


Heads Cost heads

AInvesting for future (100%

allocation)

Advertisement cost, Training expenses

and Business development expenses

BCost of new business acquisition

(100% allocation)

Travel, conveyance cost, Comminication

expenses, Medical fees, Policy issuance

and servicing cost

CCost of new business acquisition

(75% allocation)

75% of Employee cost, Rents, Printing &

staintionery, Repairs, Computer

expenses, general office expenses and

service tax

DCost of servicing existing

businesses

Other costs not accounted above and

25% of costs accounted in C

Page 23 of 47

Research


MARKET UPDATE

India | Financial Services | Small & Mid Cap | 5-June-2014

Max India

Firing on all cylinders

Max India remains our top pick in the life insurance space given the

quality of its franchise and industry leading operating metrics. Its Q4

results further strengthens our view on the company. With the

economy expected to revive over the next year we expect its new

business premium growth rates to pick up further and RoEV to

improve from current levels. The passage of the Insurance

Amendment Bill in the parliament can further help the stock to

rerate. We remain Buyers, with a new fair value of Rs405 (from

Rs308).

All businesses on track to deliver more growth

At its Q4 results on 28 May 2014, Max India reported growth on all metrics

across its businesses, with consolidated profitability growing more than 100%

for the quarter on a YoY basis. We are of the view Max is the best placed

listed play on Indian life insurance, with its subsidiaries providing further

upside.

Consistent performance from Life insurance: Notwithstanding investor

concerns — from the impact of new regulations to the cobrapost expose —

Max registered 17% growth in new business for FY14. It also reported 13%

growth in new business profits. We have consistently argued that this is a top

quality business and we expect business to grow at more than 15% over the

next few years. The company reported a RoEV of c.15% (operating profits) in

FY14; with the economy stabilising we expect RoEV to be >17% over the next

three years.

Subsidiaries showing good results: The healthcare business had been burning

capital through its expansion phase over the past four years; however, with

1,440 beds now operational, it has shown a significant improvement in

margins, with the current quarter EBITDA margins at 10.3%. With the

utilisation levels improving we expect this business to break even and start

generating profits in FY15. The company expects to increase the bed capacity

by a further 1000-1500 over the next few years (it intends to raise the capital

at the healthcare level).

The Health insurance business (Max Bupa) could need a further c.Rs2bn in the

next few years (assuming Gross Premium CAGR of 30% over the next three

years). This business is growing very fast and is complementary to the

Healthcare franchise. These two businesses should add to the valuation in

future, though in the near-term the subsidiaries do complicate the equity

story.

Insurance bill can act as a catalyst: There are widespread expectations that

the long awaited insurance bill could be passed in the parliament with an

increase in FDI cap. This could be a big catalyst for the stock given that it can

bring a lot of investor interest in the sector and in the company which could

be the best way to play a structural story.

Valuation

Our SOTP model values the company at Rs405, implying an upside of 24%

from current market price. We value the insurance business at Rs116bn, valuing

it FY16E EV + 18x FY16E NBAP, and the healthcare business at Rs45 per share

(see table 4 for detailed valuation).

Accounting & corporate governance GREEN

Franchise Strength GREEN

Earnings Momentum GREEN

BUY 24% upside

Fair Value Rs405.00

Bloomberg ticker MAX IN



Free Float 65%

INR m Y/E 31-Mar 2013A 2014E 2015E 2016E

Revenues 106,236 116,832 120,620 133,228

Operating Expenditure 94,110 111,777 115,000 125,799

EBITDA 12,126 5,056 5,619 7,429

PBT 9,914 2,744 3,309 5,043

PAT after MI 7,841 1,394 1,985 3,026

EPS 29.4 5.2 7.5 11.4

EVPS 141.0 148.4 160.6 175.2

Exceptional gain of Rs8022mn in 2013 on account of stake sell

in Life Insurance

Y/E 31-Mar 2013A 2014E 2015E 2016E

RoEV (Max Life) 10% 13% 17% 19%

NBAP Margin (Max Life) 13.6% 13.1% 11.5% 12.5%

P/EV (Max Life) 2.5 2.4 2.2 2.0

P/E 11.1 62.3 43.7 28.7

P/B 3.0 2.9 2.8 2.6

Debt/Equity 0.3 0.3 0.3 0.3

RoA 3.7% 0.6% 0.7% 0.9%

RoE 29% 5% 6% 9%


Data, Bloomberg

60

80

100

120

140

160

Jul 2013

Aug 2013

Sep 2013

Oct 2013

Nov 2013

Dec 2013

Jan 2014

Feb 2014

Mar 2014

Apr 2014

May 2014

Jun 2014

MAX IN vs BSE500 Index

Share Price Performance


Page 24 of 47

Page 2 of 12

Source: Espirito Santo Investment Bank, Company Data and Bloomberg

Valuation Metrics 2013 2014 2015E 2016E 2017E

Recommendation: BUY Equity Value

Fair Value: INR 405 P/E 11.1 62.3 43.7 28.7 21.6

P/B 3.0 2.9 2.8 2.6 2.4

Share Price: INR 326 P/EV 2.5 2.4 2.2 2.0 1.8

Upside / Downside 24% P/FCF 22 21 20 17 16

Debt/Equity 0.3 0.3 0.3 0.3 0.3

3 Month ADV ($m) 2 RoA 3.7% 0.6% 0.7% 0.9% 1.1%

Free Float 65% RoE 29.0% 4.7% 6.5% 9.3% 11.4%

52 Week High / Low 151-295 Div yield 2.7% 3.3% 4.0% 5.0%

Bloomberg: MAX IN

Model Published On: 05 June 2014 Life Insurance 2013 2014 2015E 2016E 2017E

APE 15,663 18,348 21,613 26,938 33,587

Shares In Issue (mm) 266 NBAP 2,130 2,400 2,486 3,367 4,198

Market Cap ($mn / Rs bn) $1447 mn/Rs.87bn NBAP Margin 14% 13% 12% 13% 13%

Return on Net worth/Unwind 3,920 3,790 4,546 5,132 5,600

PAT 3,740 5,060 7,031 8,499 9,798

ROEV 10% 13% 17% 19% 20%

Embedded Value (Balance Sheet) 37,560 39,530 42,768 46,666 50,658

EV per Share 141 148 161 175 190

Forthcoming Catalysts

FDI in Insurance P&L Summary 2013 2014 2015E 2016E 2017E

Revenues 106,236 116,832 120,620 133,228 155,730

Life Insurance 65,697 72,118 74,349 79,469 95,709

Espirito Santo Securities Analyst Health Insurance 1,183 2,377 3,436 4,871 6,656

Santosh Singh, CFA Health Care 7,384 9,679 12,262 14,611 16,550

(91) 22 43156822 Speciality Films 7,673 7,332 9,350 10,800 10,800

[email protected] Investment Income 23,792 26,921 21,736 24,691 27,878

Nidhesh Jain Other Subsidiaries 1,046 886 886 886 886

(91) 22 43156823 Operating Expenditure 94,110 111,777 115,000 125,799 146,128

[email protected] Raw material costs 9,243 8,519 12,600 14,546 15,167

Change in Policy Reserves 30,507 42,289 27,977 34,346 41,958

Employee expenses 8,796 9,568 10,613 11,679 12,751

Shareholding Pattern (Mar'14) Benefits Paid 27,530 30,680 42,978 41,909 48,001

Commissions 6,269 7,107 7,826 9,386 11,683

Other Expenses 11,765 13,614 13,006 13,935 16,568

EBITDA 12,126 5,056 5,619 7,429 9,602

Depreciation 1,368 1,379 1,448 1,520 1,673

Finance cost 845 932 863 866 868

Exceptionals - - - - -

Profit before tax 9,914 2,744 3,309 5,043 7,061

Taxes 1,419 650 662 1,009 1,554

Profit after Tax 8,495 2,094 2,647 4,034 5,508

Minority Interest 654 700 662 1,009 1,487

Net Profit/ (Loss) 7,841 1,394 1,985 3,026 4,021

EPS 29.4 5.2 7.5 11.4 15.1

Growth YoY 2013 2014 2015E 2016E 2017E

Revenue Breakdown - FY14 Revenues 10% 3% 10% 17%

PBT -75% 26% 52% 37%

EPS -82% 42% 52% 33%

Life Insurance (Growth YoY) 2013 2014 2015E 2016E 2017E

New premium 0% 19% 16% 22% 22%

Renewal Premiums 6% 6% -2% -1% 19%

Total Premiums 4% 10% 3% 7% 20%

Commissions 6% 11% 9% 19% 24%

Operating Expenses -2% 3% 3% 6% 20%

Commissions as % of Premium 9.2% 9.4% 9.9% 11.0% 11.3%

Opex as % of Total Premium 19% 17% 17% 17% 17%

Balance Sheet Summary 2013 2014 2015E 2016E 2017E

Margin Trends

Net Worth 29,028 29,841 31,390 33,659 36,674

Preference Share 1,250 655 655 655 655

Minority Interest 7,350 8,205 8,867 9,876 11,363

Borrowings 6,763 7,070 7,023 7,107 6,781

Deferred tax liability 190 148 148 148 148

Policyholders' Liabilities 187,900 226,609 265,084 299,430 341,389

Total Liabilities 232,481 272,528 313,167 350,875 397,009

Fixed Assets 13,610 14,945 15,363 16,223 17,211

Goodwill on consolidation 3,287 3,142 3,142 3,142 3,142

Investments 210,913 251,336 290,574 326,904 370,297

Loans and Advances & Treasury Assets 4,932 3,969 4,951 5,469 7,222

Net current assets -260 -863 -863 -863 -863

Total assets 232,481 272,528 313,167 350,875 397,009

Max India

Promoter

40%

FII

28%

DII

24%

Others

8%

Life

Insurance

83%

Health

Care

8%

Speciality

Films

7%

Others

2%

0%

5%

10%

15%

20%

25%

30%

35%

FY13A FY14A FY15E FY16E

Opex Ratio RoE

Page 25 of 47

Page 3 of 12

Max Life remains the best placed life

insurer amid regulatory uncertainty

which is evident from its exceptional

performance of last three years.

Stock rerated in the recent past

Max India stock is up by more than 35% YTD on the back of strong numbers in

the life insurance company, general bullishness in the market and also

expectation of insurance bill getting passed in the parliament. We think

despite this strong performance there is significant upside left in the stock

given

Operational performance has been exceptional

In a challenging environment Max is again proving why it has such a strong

business, and is gaining significant market share. The healthcare business also

has shown significant improvements in operations, with margins improving

(see figure below). The health insurance business has seen premium growing

at more than 38% on a YoY basis.

Life insurance outperforming: Our discussion with investors suggest that they

were not expecting any growth from the life insurance business in FY14 and

many were even concerned about statutory profitability; however, the

performance of the company over the last year clearly shows a materially

better picture.

Premiums have grown: The company registered growth of more than 15% for

FY14 with Q4FY14 seeing growth in excess of 20% despite the tough

backdrop. It is the only firm that has consistently seen growth in new business

premiums for the last four quarters; and has also increased its market share

significantly (market share chart), now with more than 6% market share of

private sector life insurance business. We expect it to grow at more than 15%

for next four years with potential upgrade if the savings rate were to improve

from here.

Figure 1 Max Life has gained market share in last five years


NBP margin fall in line with expectations: We expected the current year

margin to be in the range of 12%-13%, however it came at 13.5%. For the next

year we expect margins to be in the range of 11%-12%. From then we expect

margins to start improving;

We would expect the product profile to change: More than 65% of its

premium comes from the par business, which is capital light but low margin

(c.10%) on account of its long-term nature and shift in customer preference

towards these products. We expect the company to change its product profile

more towards higher margin businesses with a higher proportion of mortality

and longevity risk. Writing more par business made sense in the previous

regime due to the arbitrage opportunity (high charges and lower surrender

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

2009 2010 2011 2012 2013 2014

Max L

ife

's m

ark

et

sh

are

am

on

g

pri

vate

pla

ye

rs

Page 26 of 47

Page 4 of 12

We expect product profile to change

with higher proportion of high margin

non-participating products.

Max India’s subsidiaries except Max

Bupa will not need further capital.

rates on traditional policies) available to the life insurance company to

generate higher returns without taking any risk. However, with the new rules

impinging the arbitrage opportunity considerably and companies such as Max

Life sitting on a huge solvency surplus (485%) we would expect the product

suite to be more risk based, leading to higher margins. We expect the margins

to settle to 12%-13% over the long term.

Persistency provides for some upside: Regular changes in regulation meant

that there was considerable stress on persistency, although Max India has

done really well in not showing material reduction in persistency; however

there has been some decline in its unit linked portfolio which has completed

three years. With the regulatory environment stabilizing we would expect

persistency levels to get better, which should help margins.

Economies of scale: Max is a big player in the agency-based business, which

has a high fixed cost. With the company taking many initiatives, regulatory

environment stabilizing and agency channel maturing (proportion of higher

vintage agents increasing) we would expect this channel to start showing

economies of scale and higher persistency.

As of now we are not pricing in any increase in margins and we assume

margins of around 12% (FY15 onwards); however, this could be a significant

source of upgrades.

Cash generation will remain high: There were concerns from several investors

that the company would see a reduction in cash generation once the pool of

surrender profits dries up and growth returns. We may expect muted growth

in cash profit FY15 given that the company is trying to change the product mix

to high cash strain and high margin businesses and also we expect the growth

rates to be more than 15% for the company.

Capital consumptive phase in other businesses ending…

The key other businesses, i.e. Healthcare and Health insurance, are capital

intensive in nature and with capital infusion in the healthcare business finishing

and more than 70% of capital infusion in health insurance already done, the

market should start gaining greater confidence in these businesses;

Healthcare on the verge of breakeven: Max India was in a capital infusion

phase in this business until last year, given it was rapidly expanding bed

capacity. However, with it tying up all the capital it needs for this business

from strategic investors (see figure below) and with economies of scale

expected to kick in as the company increases operational beds to 1900 till

H1FY15 we expect this business to break even by the end of the fiscal year and

start generating profits from next year (see table below).

Page 27 of 47

Page 5 of 12

Figure 2 Max healthcare capital employed and equity allocation

Source: Espirito Santo Investment Bank Research, Company Data, Left edge of the box denote the year of equity allocation, Height of the box denotes the implied value of iMax healthcare from the transaction

Figure 3 Operational beds Figure 4 MHC EBITDA


Figure 5 Max healthcare has been high return generator for Max India

2001-

03 2006 2007 2012

Our

Valuation

Valuation

by IFC

Capital allocation by Max India towards MHC

104 407 216 1,400 8,529 14,160

IRR

29% 39%


-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20,000

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Max h

ealt

hcare

(C

ap

ital

Em

plo

ye

d),

Rs M

n

Total Equity capital employed Preference Share Loan Funds

Alloted 12%

stake. Valuing MHC at 1.65bn

Alloted 14% stake to

Warburg Pincus

valuing MHC at 1.81bn

Alloted 20% stake to

Warburg Pincus valuing

the company at 8.26bn

Alloted 4% stake to IFC

Company valued at 13bn

Alloted 26%

equity to Life

Healthcare

valuing MHC at

19.9bn

IFC converted

preference

shar, valuaing

the compant

at 21.5bn

0

200

400

600

800

1000

1200

1400

1600

1800

2000

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15E

Op

era

tio

nal

Be

ds

330 beds to get

operational in

FY14

-200

0

200

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600

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1200

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20

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20

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MH

C's

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ITD

A (

Rs. M

n)

Page 28 of 47

Page 6 of 12

Going by Max Bupa’s last three year

performance, it could be a significant

value creator for shareholders.

Company expects to increase the bed capacity by 1000-1500 over the next

few years which will mean that the healthcare business will need capital

however Max intends to raise that capital at the healthcare company level.

Health insurance fast growing: This business has remained in a capital infusion

phase and will continue for the next few years given its rapid growth (more

than 50% YoY), and with it trying to enter into bancassurance tie ups with

banks more capital will be needed. But we think it could be one of the big

future valuation drivers given the quality of the business (conservation ratio of

more than 80% and claims ratio of less than 60%). In our recent general

insurance thematic (LINK) we argued why we expect health insurance to be

one of major drivers for growth of the non–life insurance sector in India given:

a) Medical costs are increasing, and so more and more people are opting for

the safety net of health insurance

b) The general public is now more aware of medical insurance and how it

works and thanks to the increased awareness this segment is already

registering good levels of growth.

It has shown more than 25% growth over the past five years and we are now

seeing a few independent health insurance companies start up.

Figure 6 Net earned premium growth has been robust… Figure 7 …with strong conservation ratio


Speciality films business is expected to be hived off: The company has plans

to hive-off its speciality business and bring strategic investors who can

facilitate growth. This would reduce the economic interest of the holding

company and hence reduce the overhang/volatility on account of Speciality

films on Max India.

Nevertheless, the existence of different subsidiaries with distinct drivers, and

at various stages of development, does complicate the overall equity story,

and put off some investors looking for purer exposure to life insurance.

However, as subsidiary performance improves, and insurance overall becomes

an increasingly important driver of profitability and valuation, these concerns

should wane sometime.

0

100

200

300

400

500

600

700

800

Ne

t e

arn

ed

pre

miu

m (

Rs. M

n)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Co

nse

rvati

on

rati

o

Page 29 of 47

http://publication.espiritosantoib.co.in/Get.aspx?ID=f5ee7a46-d861-4ceb-9058-e27eb28ff330

Page 7 of 12

Old vs. New

We have tweaked our estimates a bit after the release of FY14 numbers. We

have increased our new business premium numbers and reduced our margin

estimates for FY15. The embedded value estimates are lower than our

previous estimates on account of increase in dividend pay-out ratio.

Figure 8 Old Versus New

Rs millions Old New % Change Comments

First Year Premium (APE)

FY15 20,149 21,613 7% Premium growth for H1 remained in

line with our expectations

FY16 22,554 26,938 19%

VNB

FY15 2,518 2,486 -1%

FY16 2,819 3,367 19%

Embedded Value

FY15 46,178 42,768 -7% EV estimates are lower as company

has increased dividend pay-out

FY16 51,043 46,666 -9%

EVPS

FY15 174 161 -8%

FY16 192 175 -9%


Valuation

We value Max India on a SOTP basis as the company operates four different

business segments to arrive at a fair value of Rs405. The Life Insurance

segment contributes more than 75% to our valuation. We have used the

Appraisal value methodology to value the Life Insurance entity with a NBAP

multiple of 18x. We have used a higher NBAP multiple (versus 12x-15x for other

life insurers under our coverage) for the company given the better visibility on

growth and its high quality franchise.

Max Healthcare is valued using a cash flow methodology. At our valuation the

implied EV/EBITDA multiple for the company is 8.4x FY16E EBITDA which

seems reasonable when compared with listed peers (11x-18x). Max Bupa is

valued on a capital infused basis and Speciality films business is valued at

6xFY16E EBITDA.

Our change in fair value from Rs308 to Rs405 is driven by a) rolling over our

valuation to FY16 and b) upgrades in Life Insurance on account of higher than

expected growth in new business premiums in FY14.

Page 30 of 47

Page 8 of 12

Table 1 Max India SOTP

Business Segment Valuation Max India

Stake

Value per

share Methodology

Life Insurance 115,672 72% 314

Appraisal Value Method

(FY16E EV + 18x FY16 NBAP)

Max Healthcare 18,260 66% 45 Discounted Cash Flow

Max Bupa 6,690 74% 19 Value of Capital Infused

Speciality Films 7,560 100% 28

EV/EBIDTA Multiple (6x

FY16 EBIDTA)

Total SOTP Valuation 405


Page 31 of 47

Page 9 of 12

Valuation Methodology

We have valued the company on sum of the parts basis. We value the Life

Insurance entity using the Appraisal Value Methodology with FY16 as the base

year for embedded value. We have used a NBAP multiple of 18. Max

Healthcare is valued using discounted cash flow methodology with 10 years of

explicit forecast, terminal growth rate of 8% and cost of equity of 12%. Max

Bupa is valued at capital infused basis and Max Specialty films is valued

6xFY16E EBITDA

Risks to Fair Value

We believe the regulatory overhang is over for the Life Insurance sector, and

any further regulatory intervention will be a risk to our fair value. Moreover, we

expect the loss making entities Max Bupa and Max Healthcare to break even

by FY16 and FY15, respectively. Any deterioration in the operating

environment of these entities that could delay the breaking even of these

entities will be a risk to our consolidated profitability estimates and fair value.

Page 32 of 47

Research


SILVER BULLETS


Bajaj Finserv

Prefered general insurance play

Bajaj Finserv is our preferred pick to play the improvement in the

Indian general insurance sector given the benign regulatory

environment and the growth potential of its general insurance

franchise. With provisioning for the erstwhile Motor third party

losses now over, we expect the company to post PAT growth of

>35% and RoEs of >25% in FY15. Its life insurance performance

remained weak in FY14, with 17% and 20% decline in new business

premiums and PAT respectively. However, AUM continued to grow

for the second consecutive quarter (Q3 and Q4FY14). We think the

life insurance business has bottomed out and expect it to report

growth in NBP from FY15 onwards. We re-iterate our BUY stance

with a revised fair value of Rs1,027 (Rs868 previously).

Best quality General Insurance franchise

We have been highlighting Bajaj Allianz General as the best quality general

insurance company in India, thanks to its consistent claims ratio, combined

ratio and industry leading RoE. With provisioning for motor third party pool

now over, we expect profitability to grow disproportionately to gross

premium (expect PAT growth >35% YoY and RoEs >25% in FY15). Moreover,

with non-life penetration at just 0.5% in India (versus 10% in developed

economies), we remain upbeat about the growth potential of the industry.

Life Insurance seems to have bottomed out

Bajaj Life has been going through a rough patch with new business premiums

continuing to decline post ULIP guidelines. The premium stabilized in FY13 but

declined 17% in FY14 on account of product design guidelines. Positively, AUM

which was declining till Q2 has now shown growth for two consecutive

quarters. With regulatory clarity, we expect the business to stabilize and

register 0%-5% growth in NBP for FY15.

Bajaj Finance is going strong

BAF continued on its growth path with 38% AUM growth, though PAT growth

was below expectations for FY14. The company is increasing the proportion of

low yielding secured loans (mortgages) which has impacted PAT growth.

Despite this, the return ratios remained strong with RoE of 19.5%. We expect

balance sheet growth to remain strong while PAT growth may lag on account

of change in balance sheet composition in FY15.

Increase in FDI limit in insurance remains a risk

Allianz holds a call option to increase its stake to 74% in both life and general

insurance by July’16 and April’16 subject to regulatory approval. In the event of

FDI cap being raised before 2016, its life and general will be consolidated at

51% and we view it as a risk.

Valuation

Our new SOTP valuation for Bajaj Finserv is Rs1,027 per share and this

assumes 49% FDI in the insurance sector. We have valued the Life Insurance,

General Insurance and Financing business at Rs124bn, Rs81bn and Rs95.3bn

respectively.

Accounting & corporate governance GREEN


Earnings Momentum AMBER

BUY 12% upside

Fair Value Rs1,027.00

Bloomberg ticker BJFIN IN



Free Float 41%

INR m Y/E 31-Mar 2013A 2014E 2015E 2016E

Total Income 50,749 60,250 72,285 86,154

Total expenses 23,668 31,234 41,446 51,414

Profit before tax 27,081 29,016 30,839 34,740

Profit for the year 15,736 15,441 15,745 17,504

EPS 99 97 99 110

Embedded Value 76,529 76,010 84,672 94,189

EVPS 480.7 477.4 531.9 591.6

Y/E 31-Mar 2013A 2014E 2015E 2016E

RoEV (Life Insurance) 12% -1% 11% 11%

NBAP Margin (Life Insurance) 9% 9% 12% 12%

P/EV 1.5 1.5 1.3 1.2

P/E 9.3 9.5 9.3 8.3

P/B 1.9 1.6 1.3 1.2

Debt/Equity 1.7 2.1 2.2 2.4

RoA 4% 3% 2% 2%

RoE 24% 18% 16% 15%


Data, Bloomberg

80

100

120

140

Jul 2013

Aug 2013

Sep 2013

Oct 2013

Nov 2013

Dec 2013

Jan 2014

Feb 2014

Mar 2014

Apr 2014

May 2014

Jun 2014

BJFIN IN vs BSE500 Index



Page 33 of 47

Page 2 of 7

Source: Espirito Santo Investment Bank Research, Bloomberg, Company Data


Recommendation: BUY P/E 9.3 9.5 9.3 8.3 6.9

Fair Value: INR 1027 P/B 1.9 1.6 1.3 1.2 1.0

P/EV (Life Insurance) 1.5 1.5 1.3 1.2 1.1

Share Price: INR 917 P/FCF (Life Insurance) 9 11 13 13 11

Upside / Downside 12% Debt/Equity 1.7 2.1 2.2 2.4 2.4

RoA 4% 3% 2% 2% 2%

3 Month ADV ($m) 2 RoE 24% 18% 16% 15% 15%

Free Float 41%

52 Week High / Low 563-939

Life Insurance 2013 2014 2015E 2016E 2017E

Bloomberg: BJFIN IN

Model Published On: 05 June 2014 APE 20,736 16,982 18,341 20,175 22,192

NBAP 1,910 1,487 2,201 2,320 2,663

NBAP Margin 9% 9% 12% 12% 12%

Shares In Issue (mm) 159 Return on Net worth/Unwind 5,421 6,505 6,461 7,197 8,006

Market Cap ($bn / Rs bn) $2355 mn/Rs.146bn PAT 8,771 (519) 8,662 9,517 10,669

ROEV 12% -1% 11% 11% 11%


EV per Share 481 477 532 592 659


Q1 results P&L Summary 2013 2014 2015E 2016E 2017E

Monthly premium numbers

Transfer from Policyholders' account 9,175 6,391 5,180 4,838 5,926

Operating profit from General Insurance 3,339 4,720 7,166 8,356 9,894

Espirito Santo Securities Analyst Interest income from financing 29,248 37,886 48,804 60,267 72,155

Santosh Singh, CFA Wind Mill 734 604 647 692 740

(91) 22 43156822 Investment & other 8,254 10,649 10,488 12,000 13,666

[email protected] Total Income 50,749 60,250 72,285 86,154 102,381

Nidhesh Jain Contribution to shareholders' account 24 69 - - -

(91) 22 43156823 Employee expenses 3,343 4,407 5,483 6,570 7,721

[email protected] Loan loss provisions 1,818 2,578 3,855 4,426 5,195

Financing cost 12,036 15,619 21,222 27,189 31,672

Depreciation 173 309 309 309 309

Shareholding Pattern (Mar'14) Other expenses 6,276 8,251 10,577 12,920 15,447

Total expenses 23,668 31,234 41,446 51,414 60,343

Profit before tax before exceptionals 27,081 29,016 30,839 34,740 42,037

Exceptionals - - - - -

Profit before tax 27,081 29,016 30,839 34,740 42,037

Taxes 4,939 7,105 8,310 9,561 11,665

Profit after tax 22,142 21,911 22,529 25,179 30,372

Minority Interest and profit from associates 6,405 6,470 6,784 7,674 9,350

Profit for the year 15,736 15,441 15,745 17,504 21,023

EPS 99 97 99 110 132

Growth YoY 2013 2014 2015E 2016E 2017E

Revenues 19% 20% 19% 19%

PBT 7% 6% 13% 21%

EPS -2% 2% 11% 20%

Revenue Breakdown - FY13


New premium 10% -13% 8% 10% 10%

Renewal Premiums -18% -17% 14% 6% 6%

Total Premiums -8% -15% 11% 8% 8%

Commissions -26% 5% 9% 9% 9%

Operating Expenses 14% -27% 0% 8% 2%

Commissions as % of Premium 7% 7% 7% 7% 7%

Opex as % of Total Premium 23% 20% 18% 18% 17%


Shareholders' fund 78,015 93,112 108,856 126,361 147,383

Minority Interest 28,989 35,415 42,200 49,874 59,224

Margin Trends Funds for future apprpriation 1,741 1,840 1,840 1,840 1,840

Borrowings 129,907 197,500 244,622 299,156 353,868

Deferred Tax Liabilities 88 88 88 88 88

Other Liabilities 333,490 331,109 344,834 361,557 380,651

Total Liabilities 572,230 659,064 742,440 838,875 943,054

Fixed assets 7,806 8,477 8,192 8,281 8,371

Goodwill on consolidation 4,290 4,290 4,290 4,290 4,290

Investments 432,479 451,099 486,103 526,089 572,412

Deferred tax assets 1,312 1,312 1,312 1,312 1,312

Loan book (financing) 167,436 229,710 284,015 347,052 412,470

Net current assets -51,958 -46,688 -52,337 -59,014 -66,666

Other assets 10,864 10,864 10,864 10,864 10,864

Total assets 572,230 659,064 742,440 838,875 943,054

Bajaj Finserv

Promoter

59%

FII

11%

DII

4%

Others

26%

Life

Insurance

65%

General

Insurance

22%

Finance

13%Others

0%

-5%

0%

5%

10%

15%

20%

25%

FY13A FY14A FY15E FY16E

Opex Ratio RoEV

Page 34 of 47

Page 3 of 7

Change in estimates

We have reduced our FY15 and FY16 new business premium estimates on

account of lower-than-expected growth in new business premium in FY14. We

expect the premium growth to remain at 8% in FY15 and 10% in FY16.

Table 1 Change in estimates

Rs millions Old New

%

Change Comments


FY15 26,290 18,341 -30% Due to lower than

expected growth in FY14

FY16 28,919 20,175 -30%

Consolidated Revenue

FY15 73,245 72,285 -1%

FY16 86,731 86,154 -1%

Embedded Value

FY15 96,223 84,672 -12%

FY16 107,872 94,189 -13%


Table 2 Bajaj Finserv - SOTP

Valuation @ 51% Valuation Stake Value of stake Per Share Value

Life Insurance 124,350 51% 63,419 398

General Insurance 81,384 51% 41,506 261

Bajaj Finance 95,274 62% 58,594 368

1,027

Valuation @ 74% Stake Value of stake Per Share Value

Life Insurance 124,350 74% 92,019 578


Bajaj Finance 95,274 62% 58,594 368

1,324

Valuation @ 26% Stake Value of stake Per Share Value

Life Insurance 124,350 26% 32,331 203


Bajaj Finance 95,274 62% 58,594 368

704


Page 35 of 47

Page 4 of 7


We have valued Bajaj Finserv on a SOTP basis. The life insurance business is

valued using the appraisal value method. The appraisal value is calculated as

the sum of one-year forward embedded value and a multiple times one year

forward new business profit (FY16E EV + 13x FY16E NBAP). For Bajaj Allianz

Life Insurance we have taken a multiple of 13x, which is lower than its peers

due to embedded value calculation based on a market consistent basis and we

expect its embedded value growth to be lower than its peers.

We have valued the general insurance business on discounted cash flow

methodology on a single stage 10 year horizon, a cost of equity of 14% and a

terminal growth rate of 5%. Bajaj Finance is valued at 10% discount to current

market capitalization of the company.

The fair value change from Rs868 to Rs1,027 is on account of roll over of our

valuations to FY16.

Figure 1 Bajaj Allianz General DCF disclosures


Risks to Fair Value

We have assumed a 51% economic interest in Life Insurance and General

Insurance which is contingent on an increase in FDI limit to 49% in insurance

by 2016. Allianz has a call option, which expires in 2016, to increase its stake to

74% in both Life insurance and General insurance. If the FDI limits are not

increased to 49%, then the stock would appreciate further from here; however

this is too long a period to take risk on. Also, if the insurance industry

improves significantly in the current year then we can see the stock continuing

to outperform.

Cost of Equity 14%

Terminal growth rate 5%

Rs. Mn

Valuation 81,384

Rs. Mn Mar-15 Mar-16 Mar-17 Mar-18 Mar-19 Mar-20 Mar-21 Mar-22 Mar-23 Mar-24

FCFE 3,394 3,950 4,731 5,640 6,897 8,134 9,576 11,241 13,165 15,363

Discount Factor 0.9 0.8 0.7 0.6 0.5 0.5 0.4 0.4 0.3 0.3

Present Value 2,977 3,040 3,194 3,339 3,582 3,706 3,827 3,941 4,048 4,144

Terminal Value 45,586

Bajaj Allianz General DCF Valuation

Page 36 of 47

Research


MARKET UPDATE


Reliance Capital

Most levered play on economic revival

Reliance Capital has been an outperformer YTD (up 61% vs 34% for

the Bankex), driven mainly by the positive market sentiment and

improvement in operations of its key life and general insurance

subsidiaries. We expect the company’s earnings to show momentum

given the positive improvement in the general insurance business,

revival of the life insurance business and continued deleveraging of

its balance sheet. We have increased our valuation of its Life

Insurance business and general insurance business (rolling over to

FY16), so our fair value moves up from Rs592 to Rs692 and we

retain our BUY rating. The Insurance Amendment Bill is a key

catalyst for the stock.

Increased earnings momentum

Most of the operating businesses of Reliance Capital have been showing

improvement on the operating front and we would expect the momentum on

earnings to increase given:

The turnaround in the life insurance business: Reliance Life was one of the

worst performing businesses in the life insurance space over 2010-2013 given

its dependence on the agency channel and the change in ULIP guidelines.

However in FY14 the company reversed the trend and registered more than

15% growth in individual NBP. We expect this business to maintain its growth

trajectory, with c.10%-15% growth rate in FY15. We expect statutory profit to

fall in FY15 to Rs2,645mn from Rs3,589mn in FY14, mainly on account of a

significant reduction in surrender penalties; however, on a fundamental basis

we expect the cost overruns to subside and the company to register more

than 10% ROEV over the next three years.

The general insurance turnaround: Reliance Capital‖s general insurance

business has been one of the biggest drags on its profitability, with losses of

Rs3.2bn in FY12 and Rs.0.6bn in FY13. However this business turned around in

FY14, reporting a profit of Rs641mn. We expect this segment‖s profit to more

than double in FY15 as the impact of third party motor losses is now over. We

think general insurance has been one of the biggest turnaround stories in

Reliance Capital, with premiums growing at c.15%-20%, and from FY16 we

expect >15% ROE from this business.

Other businesses are linked to the economy: Two key businesses of Reliance

Capital — commercial finance and asset management — are linked to the

economy. In a difficult economic environment the company did not grow its

book instead it focussed on profitability; however we expect its commercial

finance business to start growing from FY15. Asset management and

specifically equity AUMs have a strong correlation with the equity market; the

equity AUM for the company declined 26% between FY11 and FY14. However,

the company‖s focus on retail debt helped it remain highly profitable; we

expect equity AUMs to start growing from FY15 as market performance

improves.

Valuation

Our revised SOTP valuation is Rs692 (up from Rs592). The SOTP includes

Rs244 for life insurance, Rs169 for asset management (4.5% of FY16E AUM),

Rs93 for general insurance (1.9x FY16E P/BV), Rs123 for the financing business

(1x FY16E BV) and Rs55 for unlisted equities (at 30% discount to book value).

Governance could remain an overhang on realization of Reliance‖s full

potential, but we think the discount is too high.

Accounting & corporate governance AMBER


Earnings Momentum GREEN

BUY 11% upside

Fair Value Rs692.00

Bloomberg ticker RCAPT IN



Free Float 50%

INR m Y/E 31-Mar 2013A 2014E 2015E 2016E

Revenues 75,190 75,440 83,290 95,403

Total expenses 43,460 41,960 46,041 52,648

Profit before tax (PBT) 8,300 8,470 9,051 11,737

Profit for the year 8,120 7,470 7,763 8,898

EPS 33 30 32 36

Embedded Value * 30,908 31,937 35,224 39,957

* Our estimates for all years

Y/E 31-Mar 2013A 2014E 2015E 2016E

RoEV (Life) -2% 3% 10% 13%

NBAP Margin (Life) 20% 16% 14% 14%

P/EV (Life) 2.4 2.3 2.1 1.8

RoA (Cons.) 1.5% 2.4% 2.0% 1.9%

RoE (Cons.) 4.6% 6.8% 6.1% 6.1%

P/E 18.8 20.5 19.7 17.2

P/B 1.3 1.2 1.2 1.1

Debt/Equity 1.3 1.2 1.2 1.1


Data, Bloomberg

80

100

120

140

160

180

Jul 2013

Aug 2013

Sep 2013

Oct 2013

Nov 2013

Dec 2013

Jan 2014

Feb 2014

Mar 2014

Apr 2014

May 2014

Jun 2014

RCAPT IN vs BSE500 Index



Page 37 of 47

Page 2 of 11

Source: Espirito Santo Investment Bank Research, Bloomberg and Company Data;


Recommendation: BUY Equity Value

Fair Value: INR 692 P/E 18.8 20.5 19.7 17.2 14.8

P/B 1.3 1.2 1.2 1.1 0.0

Share Price: INR 622 P/EV 2.4 2.3 2.1 1.8 0.9

Upside / Downside 11% RoA 1.5% 2.4% 2.0% 1.9% 2.0%

RoE 4.6% 6.8% 6.1% 6.1% 6.5%

3 Month ADV ($m) 14 Debt/Equity 1.3 1.2 1.2 1.1 0.0

Free Float 50%

52 Week High / Low 596-290

Life Insurance 2013 2014 2015E 2016E 2016E

Bloomberg: RCAPT IN

Model Published On: 05 June 2014 APE 12,072 18,460 21,229 24,414 28,076

NBAP 2,439 2,954 2,972 3,418 3,931

NBAP Margin 20% 16% 14% 14% 14%

Shares In Issue (mm) 246 Return on Net worth + Unwind of discount rate 3,955 4,075 4,315 4,315 40,277

Market Cap ($bn / Rs bn) $2550 mn/Rs.153bn PAT (606) 1,029 3,287 4,733 41,209

ROEV -2% 3% 10% 13% 68%


EV per Share 126 130 143 162 330


Insurance Amendment Bill Passage

Proposed stake sale in General Insurance P&L Summary 2013 2014 2015E 2016E 2016E

Revenues 75,190 75,440 83,290 95,403 104,128

Espirito Santo Securities Analyst Asset management 6,100 6,760 9,455 11,242 13,386

Santosh Singh, CFA General Insurance 24,170 29,450 31,962 37,611 44,266

(91) 22 43156822 Reliance Money 3,190 3,220 4,417 5,157 -

[email protected] Consumer Finance 21,170 22,100 23,659 26,870 30,901

Profit on sale of investments 21,810 15,050 15,050 15,652 16,591

Nidhesh Jain Standalone finance and others (1,250) (1,140) (1,254) (1,129) (1,016)

(91) 22 43156823 Total expenses 43,460 41,960 46,041 52,648 56,374

[email protected] Reinsurance premium ceded 5,340 5,790 7,659 9,038 10,664

Claims incurred 12,610 16,036 17,039 19,864 23,440

Operating expensses 25,510 20,134 21,343 23,747 22,270

Shareholding Pattern (Mar'14) Asset management 3,520 3,696 4,057 4,454 4,891

General Insurance 4,974 5,766 6,683 7,743 8,892

Reliance Money 2,577 2,876 3,218 3,610 -

Consumer Finance 4,034 4,822 4,262 4,816 5,364

Standalone finance and others 10,407 2,974 3,123 3,123 3,123

Finance Costs 23,430 25,010 28,198 31,018 34,120

Profit before tax (PBT) 8,300 8,470 9,051 11,737 13,634

Taxes 1,270 1,640 1,358 2,934 3,409

Profit after tax (PAT) 7,030 6,830 7,693 8,803 10,226

Minority Interest 1,090 (640) (70) (95) (134)

Profit for the year 8,120 7,470 7,763 8,898 10,360

EPS 33 30 32 36 42

Growth YoY 2013 2014 2015E 2016E 2016E

Revenues 0% 10% 15% 9%

Revenue Breakdown (FY14) PBT 2% 7% 30% 16%

EPS -8% 4% 15% 16%


New premium 53% 15% 15% 15%

Renewal premium -17% 55% 15% 15% 15%

Total premium -24% 40% 15% 15% 15%

Commissions -13% -4% -18% 31% 15%

Commissions/Total premium 0% 0% 0% 0% 0%

Opex/Total premium 32% 33% 34% 30% 30%


Margin Trends Shareholder's funds 119,710 123,910 131,603 140,406 150,631

Loan Funds 225,097 255,766 281,343 309,477 340,425

Total sources of funds 349,967 385,116 419,320 457,379 499,899

Fixed assets 2,230 2,500 2,500 2,500 2,500

Investments 150,860 161,570 161,570 161,570 161,570

Cash and Bank Balances 15,822 26,630 26,665 26,666 26,667

Loans and advances 202,126 224,620 245,125 268,706 295,824

Other assets (21,071) (30,204) (16,540) (2,063) 13,338

Total application of funds 349,967 385,116 419,320 457,379 499,899

BVPS 487 504 535 571 612

Reliance Capital

Promoter

54%

FII

20%

DII

6%

Others

20%

Asset

Manageme

nt

11%

General

Insurance

44%

Broking

6%

Consumer

Finance

39%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

FY2013 FY2014 FY2015E FY2016E

Opex Ratio RoEV

Page 38 of 47

Page 3 of 11

Most levered to an economic revival

Reliance Capital‖s stock has been on the move up over the past three months

on expectations of an economic revival. Also, its life insurance and general

insurance subsidiaries have shown significant improvement in underlying

earnings. We believe the company can keep performing well given:

Life insurance business back on growth path

Reliance Capital‖s life insurance business was one of the worst performing

businesses within the life insurance space over 2010-2013, with APE declining

by 65% in that period, as the company was totally dependent on agency

channel for its premium growth. However, FY14 was the year of revival for the

company, with its life insurance business registering 15% APE growth for the

full year on individual life business compared to c.3% decline for the industry.

With the agency channel expected to turnaround we expect Reliance Life to

stay on the growth trajectory (we expect 15% new business premium CAGR

over the next three years).

Figure 1 Reliance Life new business premium


However we expect statutory profit to fall as Rs1,600mn of profit in FY14 was

from earlier policies being surrendered. In our opinion the company has seen

depletion in EV over the past couple of years given the cost overruns on

account of declining new business premiums; we may see the EV depletion

trend reversing from the current year with the company starting to show

some positive EV movement. Over the next three years we would expect the

company to start generating c.15% ROEV.

We value this business using appraisal value method and arrive at a valuation

of Rs.80.9bn

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

FY08 FY09 FY10 FY11 FY12 FY13 FY14

Ne

w B

usin

ess P

rem

ium

(R

s M

n)

Page 39 of 47

Page 4 of 11

Table 1 Appraisal Valuation for Reliance Life

Value

(Rs Mn) Comments

(a) Embedded Value FY16E 39,957 Based on APE growth of 15% for

FY15 and FY16 each

(b) FY16E VNB 3,418 We have assumed 14% VNB

margins for FY16

(c) VNB Multiple 12 We have used lower multiple as

compared to 13-17x for others as its return ratios are weaker

(d) Value of future business (b*c) 41,015

Total Appraisal Value (a+d) 80,972

No. of Shares 246

Value per share 244 Based on 74% stake


General insurance

This has been the turnaround business — from incurring losses of Rs928mn for

FY13 it reported a profit of Rs641mn in FY14 despite writing off c.Rs750mn in

Third Party motor pool losses. With the overhang from Motor Third Party pool

now over profits could more than double for this business in FY15. The

company has significantly improved the quality of its business over the past

two years with dependence on motor business declining slightly. We expect

this business to show Gross Premiums growth of 15%-20% over the next three

years and expect it to generate more than 15% ROE over the next three years.

If media reports (LINK) are to be believed the company has been looking to

offload some of its holdings in this business. If FDI in insurance were to be

increased to 49%, then we expect the company to get good valuation for this

venture.

We use FCFE to value the general insurance business and arrive at a valuation

of Rs22.9bn for this business

Commercial Finance

The company has been on a consolidation phase over the past three years in

this business (see figure 2), with the focus on improving profitability of this

business. The company to a large extent has been successful in strengthening

its book with profitability of the business moving up 220% over the past four

years and the book size hardly changing. However, with the economic

environment getting better we expect Reliance Capital to start expanding this

book. We expect 15% CAGR growth in AUM for this business over the next

three years.

Page 40 of 47

http://articles.economictimes.indiatimes.com/2012-11-20/news/35203833_1_nippon-life-rcam-reliance-general-insurance

Page 5 of 11

Figure 2 Muted AUM movement over the last four years Figure 3 Profits have increased


We use excess return on equity method to value this business and get a

valuation of Rs.30.3bn for this business.

Asset management

Reliance Asset management is the second largest AMC in India. The company

lost its no.1 position to HDFC couple of years back. Its % of high margin equity

portfolio on overall portfolio declined from 36% of AUM in 2012 to 24% AUM in

2014 (figure 4). However, in this period when it was losing equity AUM the

company focused on another high margin product ―retail debt,‖ the proportion

of which increased to 33%. As a result of this strategy and some cost cutting

measures the company was able to maintain its profitability over the past

three years (figure 5). Over the past one year the company has stopped losing

market share and with the economic environment stabilizing and negative

new flows around ADAG group declining we may expect this business to start

growing.

We value this business at 4.5% of AUM, in the past the deals in the sector have

happened at 6% of AUM (see figure 6 below)

Figure 4 Reliance AMC AUM Mix (Rs Bn) Figure 5 Reliance AMC PBT (Rs Mn)


0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000


Co

mm

erc

ial

Fin

an

ce

Lo

an

bo

ok

(Rs M

n)

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000


Co

mm

erc

ial

Fin

an

ce

PB

T

(Rs M

n)

0

200

400

600

800

1000

1200

2011 2012 2013 2014

AU

M (

Rs B

n)

Debt Equity0

500

1000

1500

2000

2500

3000

3500

4000

2011 2012 2013 2014

Re

lian

ce

AM

C P

BT

(R

s M

n)

Page 41 of 47

Page 6 of 11

Figure 6 Deals in the asset management space over the last few years

Transaction Date AUM

(Rs. Bn)

Debt: Equity proportion in

AUM at the time of deal

Valuation paid

by the buyer

as % of AUM

Eton park bought 5% stake in Reliance AMC Dec-07 773 56:44 12.90%

Valiant, Blue Ridge and Eaton Park bought stake in JM MF Jul-08 111 62:38 7.30%

IDFC bought Standard Chart AMC Mar-08 140 71:29 5.70%

T Rowe Price bought 26% stake in UTI AMC Nov-09 768 72:28 3.30%

Nomura bought 35% stake in LIC AMC Jul-08 324 96:04 2.50%

Religare bought Lotus AMC (distress sale) Nov-11 55 90:10 1.80%

L&T bought DBS Cholamandlam AMC Sep-09 29 92:08 1.60%

Nippon bought 26% in Reliance AMC Jan-12 843 60:40 6.64%

L&T Finance bought Fidelity Mar-12 88 32:68 6%+


Balance Sheet has been a cause for concern

Although the performance of all the businesses has improved significantly its

bloated Balance Sheet has been a concern. The company has been trying to

resolve this issue and has been successful partially; however resolving its

balance sheet issue fully would be one of the key areas that can help the

company rerate from here on.

Old vs. New

Figure 7 Old vs. New

Rs millions Old New

%

Change Comments


FY15

14,994 21,229 42% On account of higher than expected growth in FY14

FY16 17,243 24,414 42%

Consolidated Revenue

FY15 75,050 83,290 11%

FY16 88,535 95,403 8%

PAT after MI

FY15 6,782 7,763 14%

FY16 8,590 8,898 4%

EPS

FY15 18 32 75%

FY16 35 36 4%

Source: Espirito Santo Investment Bank. We have consolidated life insurance at 38% and Asset management at 70%

Page 42 of 47

Page 7 of 11


We have valued the company on SOTP basis. The life insurance business is

valued using an Appraisal Value Method. The Appraisal Value is calculated as

the sum of one year forward embedded value and a multiple times one year

forward New Business Profit (FY16E EV + 12x FY16E NBAP). We have taken a

multiple of 12x for Reliance Life Insurance.

We have valued asset management at 4.5% of FY16E AUM. The broking and

general insurance businesses are valued using discounted cash flow

methodology using a cost of equity of 14%. The consumer finance business is

valued using excess return on equity method with cost of equity of 13%.

Figure 8 SOTP Valuation for Reliance Capital

Business Segment Value per

share Methodology

Life Insurance 244 Appraisal value method (EV + 12x

FY16E NBAP)

Asset Management 169 % of AUM (4.5% of FY16E AUM)

Consumer Finance 123 Excess return on equity method

Broking and distribution 8 Discounted Cash Flow

General Insurance 93 Discounted Cash Flow

Unlisted equity 55 30% of listed and unlisted

investments

Total SOTP Valuation 692

Source: Espirito Santo Investment Bank

Figure 9 Reliance General DCF Valuation Disclosures


Cost of Equity 14%

Terminal growth rate 5%

Rs. Mn

Valuation 22,945

Rs. Mn Mar-15 Mar-16 Mar-17 Mar-18 Mar-19 Mar-20 Mar-21 Mar-22 Mar-23 Mar-24

FCFE 245 548 674 1,472 696 1,278 2,056 3,078 3,920 4,956

Discount Factor 0.9 0.8 0.7 0.6 0.5 0.5 0.4 0.4 0.3 0.3

Present Value 215 422 455 872 362 582 822 1,079 1,205 1,337

Terminal Value 15,595

Reliance General DCF Valuation

Page 43 of 47

Page 8 of 11

Figure 10 Reliance Commercial Finance Valuation Disclosures


Risks to Fair Value

Although we have highlighted that there is a great deal of value in this stock,

clearly in the shorter term it tends to react to news flow around the ADAG group

and in recent times that news flow has been consistently negative. We recognise

that the management has tried to ring fence the company from group concerns,

implementing a number of initiatives to highlight functional independence and

minimal intercompany linkages, but having a common promoter means there will

always be a perception of linkage, and clearly the quantum of the promoter‖s

stake suggests considerable influence.

Cost of Equity 13%

Shares in Issue 246

Rs. Mn Rs./share

Free cash flow to equity NPV 30,308 123

Rs. Mn Mar-15 Mar-16 Mar-17 Mar-18 Mar-19 Mar-20 Mar-21 Mar-22 Mar-23 Mar-24 Mar-25 Mar-26 Mar-27 Mar-28 Mar-29 Mar-30 Mar-31 Mar-32 Mar-33 Mar-34

Beginning book Value 26,080 29,832 34,263 39,479 45,540 52,482 60,299 69,020 78,709 89,470 101,423 114,935 130,207 147,461 166,949 188,952 213,787 241,809 273,418 309,061

Net Profit 3,752 4,431 5,216 6,061 6,942 7,817 8,722 9,688 10,762 11,952 13,513 15,272 17,254 19,488 22,003 24,835 28,023 31,609 35,643 40,178

Cost of Equity 3,390 3,878 4,454 5,132 5,920 6,823 7,839 8,973 10,232 11,631 13,185 14,942 16,927 19,170 21,703 24,564 27,792 31,435 35,544 40,178

ROAE 14% 15% 15% 15% 15% 15% 14% 14% 14% 13% 13% 13% 13% 13% 13% 13% 13% 13% 13% 13%

Excess Return 361 553 762 928 1,022 994 883 716 529 321 328 330 327 318 300 271 230 174 98 -

Discount Factor 0.9 0.8 0.7 0.6 0.5 0.5 0.4 0.4 0.3 0.3 0.3 0.2 0.2 0.2 0.2 0.1 0.1 0.1 0.1 0.1

Present Value 320 433 528 569 555 477 375 269 176 95 85 76 67 57 48 38 29 19 10 -

Reliance Commercial Finance

Page 44 of 47

Page 25 of 27

Please visit our website at www.EspiritoSantoIB.co.uk for up to date recommendation charts.

Max India MAX IN

Report date Recommendation Fair value Share price

2013 May 31 Buy Rs308.00 Rs218.75

May 3 Buy Rs307.58 Rs216.90

April 30 Buy Rs279.00 Rs213.00

2012 August 22 Buy Rs279.42 Rs181.70

April 13 Buy Rs279.00 Rs204.00

February 16 Buy Rs252.00 Rs188.00

Source: Bloomberg, Espirito Santo Investment Bank Research

B

BB

BB

B

100

120

140

160

180

200

220

240

260

280

300

Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14

Buy Trading Buy Neutral Trading Sell Sell Restricted Dropped Coverage

Bajaj Finserv BJFIN IN


2013 November 22 Buy Rs868.00 Rs707.85

July 2 Buy Rs859.00 Rs643.00

2012 September 24 Sell Rs768.94 Rs779.50

August 22 Sell Rs767.56 Rs942.70


B

B

S

S

400

500

600

700

800

900

1000



Reliance Capital RCAPT IN


2013 July 2 Buy Rs592.00 Rs361.00

2012 September 24 Buy Rs679.11 Rs399.90

August 22 Buy Rs679.16 Rs359.35

February 16 Buy Rs745.00 Rs431.00

2011 September 15 Buy Rs820.00 Rs413.00


B

B

B

B

B

200

250

300

350

400

450

500

550

600

650



Page 45 of 47

http://www.espiritosantoib.co.uk/

Page 10 of 11

IMPORTANT DISCLOSURES

200514

This report was prepared by Espírito Santo Investment Bank Research, a global brand name for the equity research teams of Banco Espírito Santo de Investimento, S.A., with headquarters in Lisbon, Portugal, of its Branches in Spain and Poland and of its affiliates BES Securities do Brasil, S.A – Corretora de Câmbio e Valores Mobiliários, in Brazil, Execution Noble Limited, in the United Kingdom, and Espirito Santo Securities India Private Limited, in India, all authorized to engage in securities activities according to each domestic legislation. All of these entities are included within the perimeter of the Financial Group controlled by Espírito Santo Financial Group S.A. (“Banco Espírito Santo Group”).

Analyst Certification

Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers; the issuers were not previously informed about the content of the recommendation included in this research report and the assumptions were not validated by the issuers; (2) no part of his or her compensation is directly or indirectly related to: (a) the specific recommendations or views expressed by that research analyst in the research report; and/or (b) any services provided or to be provided by Banco Espírito Santo de Investimento, S.A. and/or by any of its affiliates to the issuer of the securities under recommendation. Moreover, each of the analysts hereby certifies that he or she has no economic or financial interest whatsoever in the companies subject to his or her opinion and does not own or trade any securities issued by the latter.

Ratings Distribution

Espirito Santo Investment Bank Research hereby provides the distribution of the equity research ratings in relation to the total Issuers covered and to the investment banking clients as of end of March 2014.

Explanation of Rating System Ratings Distribution

12-MONTH RATING DEFINITION

BUY Analyst expects at least 10% upside potential to fair value, which should be realized in the next 12 months

NEUTRAL Analyst expects upside/downside potential of between +10% and -10% to fair value, which should be realized in the next 12 months

SELL Analyst expects at least 10% downside potential to fair value, which should be realized in the next 12 months

As at end March 2014 Total ESIB Research

Total Investment Banking Clients (IBC)

Recommendation Count % of Total Count % of IBC % of Total

12 Month Rating:

Buy 199 46.1% 26 81.3% 6.0%

Neutral 135 31.3% 4 12.5% 0.9%

Sell 97 22.5% 2 6.3% 0.5%

Restricted 0 0.0% 0 0.0% 0.0%

Under Review 1 0.2% 0 0.0% 0.0%

TRADING RATING DEFINITION

TRADING BUY Analyst expects a positive short-term movement in the share price (max duration 3 months from the time Trading Buy is announced) and may move out of line with the fair value estimate during that period

TRADING SELL Analyst expects a negative short-term movement in the share price (max duration 3 months from time Trading Sell is announced) and may move out of line with the fair value estimate during that period

Trading Rating:

Trading Buy 0 0.0% 0 0.0% 0.0%

Trading Sell 0 0.0% 0 0.0% 0.0%

Total recommendations 432 100% 32 100% 7.4%

For further information on Rating System please see “Definitions and distribution of ratings” on: http://www.espiritosantoib-research.com.

Share Prices

Share prices are as at the close of business on the day preceding publication, unless otherwise specified.

Coverage Policy

Espírito Santo Investment Bank Research reserves the right to choose the securities it expresses opinions on. The main criteria to choose such securities are: 1) markets in which they trade 2) market capitalisation 3) liquidity, 4) sector suitability. Espírito Santo Investment Bank Research has no specific policy regarding the frequency in which opinions and investment recommendations are released.

Representation to Investors

Espírito Santo Investment Bank Research has issued this report for information purposes only. This material constitutes "investment research" for the purposes of the Markets in Financial Instruments Directive and as such contains an objective or independent explanation of the matters contained in the material.

Any recommendations contained in this document must not be relied upon as investment advice based on the recipient's personal circumstances. This report is not, and should not be construed as an offer or a solicitation to buy or sell any securities or related financial instruments. The investment discussed or recommended in this report may be unsuitable for investors depending on their specific investment objectives and financial position. The material in this research report is general information intended for recipients who understand the risks associated with investment. It does not take account of whether an investment, course of action, or associated risks are suitable for the recipient. This research report does not purport to be comprehensive or to contain all the information on which a prospective investor may need in order to make an investment decision and the recipient of this report must make its own independent assessment and decisions regarding any securities or financial instruments mentioned herein. In the event that further clarification is required on the words or phrases used in this material, the recipient is strongly recommended to seek independent legal or financial advice. Where an investment is denominated in a currency other than the investor‖s currency, changes in rates of exchange may have an adverse effect on the value, price of, or income derived from the investment. Past performance is not necessarily a guide to future performance. Income from investments may fluctuate. The price or value of the investments to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. Any recommendation and opinion contained in this report may become outdated as a consequence of changes in the environment in which the issuer of the securities under analysis operates, in addition to changes in the estimates and forecasts, assumptions and valuation methodology used herein. The securities mentioned in this publication may not be eligible for sale in some states or countries.

All the information contained herein is based upon information available to the public and has been obtained from sources believed to be reliable. However, Espírito Santo Investment Bank Research does not guarantee the accuracy or completeness of the information contained in this report. The opinions expressed herein are Espírito Santo Investment Bank Research present opinions only, and are subject to change without prior notice. Espírito Santo Investment Bank Research is not under any obligation to update or keep current the information and the opinions expressed herein nor to provide the recipient with access to any additional information.

Espírito Santo Investment Bank Research has not entered into any agreement with the issuer relating to production of this report. Espírito Santo Investment Bank Research does not accept any form of liability for losses or damages which may arise from the use of this report or its contents.

Ownership and Material Conflicts of Interest

Banco Espírito Santo de Investimento, S.A. and/or its Affiliates (including all entities within Espírito Santo Investment Bank Research) and/or their directors, officers and employees, may have, or have had, interests or qualified holdings on issuers mentioned in this report. Banco Espírito Santo de Investimento, S.A. and/or its Affiliates may have, or have had, business relationships with the companies mentioned in this report. However, the research analysts may not purchase or sell securities or have any interest whatsoever in companies subject to their opinion.

Banco Espírito Santo Group has a qualified shareholding (1% or more) in Providência. Bradesco has an indirect qualified shareholding (4.8%) in Banco Espírito Santo, S.A. and a direct qualified shareholding (20%) in BES Investimento do Brasil, S.A., the parent company of BES Securities do Brasil S.A. CCVM.

Pursuant to Polish Ministry of Finance regulations, we inform that Banco Espírito Santo Group companies and/or Banco Espírito Santo de Investimento, S.A. Branch in Poland do not have a qualified shareholding in the Polish Securities Issuers mentioned in this report higher than 5% of its total share capital.

Mr. Rafael Valverde, a member of the board of Banco Espírito Santo de Investimento, S.A., is a non-executive board member of EDP Renováveis. Mr. Ricardo Abecassis Espírito Santo Silva, a member of the board of Banco Espírito Santo de Investimento, S.A., is a board member of Brazil Hospitality Group.

Banco Espírito Santo de Investimento, S.A and/or its subsidiaries are liquidity providers or market makers for Altri, Usiminas and Vale.

Banco Espírito Santo de Investimento, S.A. and/or its subsidiaries participate or have participated in the last 12 months as a syndicate member in share offerings of 4imprint, Brazil Hospitality Group, Capital Park, CTT, EDP, Iguatemi, Just Retirement, Klabin, Liberbank, Mota-Engil, Sports Direct and Zon Optimus.

Banco Espírito Santo de Investimento, S.A. and/or its subsidiaries participate or have participated in the last 12 months as a syndicate member in the bond issues of the following companies: Abengoa, Altri, EDP, Globe Trade Centre, Kredyt Inkaso and Sonae.

Banco Espírito Santo de Investimento, S.A. and/or its subsidiaries provided in the last 12 months investment banking services to the following companies: 4imprint, Abengoa, Altri, Brazil Hospitality Group, Burford Capital, Capital Park, Casino Guichard, Dinamia, EDP, EDP Renovaveis, Ence, Galp Energia, Globe Trade Centre, Godrej Consumer Products, Iguatemi, IQE, Just Retirement, Kcom Group, Klabin, Kredyt Inkaso, Kruk, Laird, Liberbank, Mota-Engil, Novae Group Plc, REN, Semapa, Sonae, Sonaecom, Sports Direct, SVG Capital, Ted Baker, Xchanging and Zon Optimus.

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Banco Espírito Santo Group has been a partner to Mota-Engil in the infrastructure business in Portugal and other countries. Mota-Engil and Banco Espírito Santo Group, through ES Concessões, S.G.P.S., S.A., have created a joint holding company – Ascendi – for all stakes in transportation infrastructure concessions, in Portugal and abroad. Banco Espírito Santo de Investimento, S.A. provided, or continues to provide, investment banking services to Ascendi.

Banco Espírito Santo de Investimento, S.A. and/or its subsidiaries do and seek to provide investment banking or other services to the companies referred to in this research report. As a result, investors should be aware that a conflict of interest may exist.

Market Making UK

Execution Noble Limited is a Market Maker in companies covered and may sell to or buy from customers as principal in certain financial instruments listed or admitted to listing on the London Stock Exchange. For information on Companies to which Execution Noble Limited is a Market Maker please see “Execution Noble Limited UK Market Making” on http://www.espiritosantoib-research.com.

Confidentiality

This report cannot be reproduced, in whole or in part, in any form or by any means, without Espírito Santo Investment Bank Research‖s specific written authorization. This report is confidential and is intended solely for the designated addressee. Therefore any disclosure, replication, distribution or any action taken in reliance on it, is prohibited and unlawful. Receipt and/or review of this research report constitutes your agreement not to redistribute, retransmit, or disclose to others the contents, opinions, conclusion, or information contained in this report (including any investment recommendations, estimates or price targets without first obtaining express permission from an authorized officer of Banco Espírito Santo de Investimento, S.A.

Regulatory Authorities

For information on the identity of the Regulatory Authorities that supervise the entities included within Espírito Santo Investment Bank Research please see http://www.espiritosantoib-research.com.

IMPORTANT DISCLOSURES FOR U.S. PERSONS

This report was prepared by Espírito Santo Investment Bank Research, a global brand name for the equity research teams of Banco Espírito Santo de Investimento, S.A., with headquarters in Lisbon, Portugal, of its Branches in Spain and Poland and of its affiliates BES Securities do Brasil, S.A – Corretora de Câmbio e Valores Mobiliários, in Brazil, Execution Noble Limited, in the United Kingdom, and Espirito Santo Securities India Private Limited, in India, all authorized to engage in securities activities according to each domestic legislation. Neither Banco Espírito Santo de Investimento, S.A. nor these affiliates are registered as a broker-dealer in the United States and therefore, is not subject to U.S. rules regarding the preparation of research reports and the independence of research analysts. This report is provided for distribution to U.S. institutional investors in reliance upon the exemption from registration provided by Rule 15a-6 of the U.S. Securities Exchange Act of 1934, as amended.

This report is confidential and not intended for distribution to, or use by, persons other than the addressee and its employees, agents and advisors.

E.S. Financial Services, Inc. is the U.S. distributor of this report. E.S. Financial Services, Inc. accepts responsibility for the contents of this report, subject to the terms set out below, to the extent that it is delivered to a U.S. person other than a major U.S. institutional investor. Any U.S. person receiving this report and wishing to effect securities transactions in any security discussed in the report should do so only through E.S. Financial Services, Inc.

Contact Information

Garreth Hodgson Senior Managing Director / Head of Sales (212) 351-6054 [email protected]

Eva Gendell Vice President (212) 351-6058 [email protected]

Hande Cuhruk Vice President (212) 351-6070 [email protected]

Jack Fernandez Executive Director (212) 351-6064 [email protected]

James Kaloudis Executive Director (212) 351-6065 [email protected]

Mike Williams Vice President (212) 351-6052 [email protected]

Pedro Marques Vice President (212) 351-6051 [email protected]

Tatiana Sarandinaki Vice President (212) 351-6055 [email protected]

E.S. Financial Services, Inc. New York Branch 340 Madison Avenue, 12th Floor New York, N.Y. 10173

Each analyst whose name appears in this report certifies the following, with respect to each security or issuer that the analyst covers in this report: (1) that all of the views expressed in this report accurately reflect the personal views of the analyst about those securities and issuers; and (2) that no part of the compensation of the analyst was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by the analyst in this report.

The analysts whose names appear in this report are not registered or qualified as research analysts with the Financial Industry Regulatory Authority ("FINRA") and may not be associated persons of E.S. Financial Services, Inc. and therefore may not be subject to the applicable restrictions under FINRA Rules on communications with a subject company, public appearances and trading securities held by a research analyst account.

Ownership and Material Conflicts of Interest

Banco Espírito Santo de Investimento, S.A. and/or its Affiliates and/or their directors, officers and employees, may have, or have had, interests or qualified holdings on issuers mentioned in this report. Banco Espírito Santo de Investimento, S.A. and/or its Affiliates may have, or have had, business relationships with the companies mentioned in this report.

For a complete list of the covered Issuers in which Banco Espírito Santo de Investimento, S.A. or its Affiliates hold stakes in excess of 1% and for information on possible material conflicts of interest arising from investment banking activities please see “Important disclosures for US persons” on http://www.espiritosantoib-research.com.

Receipt of Compensation

For information on Receipt of Compensation from subject Issuers please see “Important disclosures for US persons” on http://www.espiritosantoib-research.com.

Representation to Investors

Espírito Santo Investment Bank Research has issued this report for information purposes only. All the information contained therein is based upon information available to the public and has been obtained from sources believed to be reliable. However, Espírito Santo Investment Bank Research does not guarantee the accuracy or completeness of the information contained in this report. The opinions expressed herein are our present opinions only, and are subject to change without prior notice. Espírito Santo Investment Bank Research is not under any obligation to update or keep current the information and the opinions expressed herein. This report is not, and should not be construed as an offer or a solicitation to buy or sell any securities or related financial instruments. The investment discussed or recommended in this report may be unsuitable for investors depending on their specific investment objectives and financial position. Where an investment is denominated in a currency other than the investor‖s currency, changes in rates of exchange may have an adverse effect on the value, price of, or income derived from the investment. Past performance is not necessarily a guide to future performance. Income from investments may fluctuate. The price or value of the investments to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. Any recommendation and opinion contained in this report may become outdated as a consequence of changes in the environment in which the issuer of the securities under analysis operates, in addition to changes in the estimates and forecasts, assumptions and valuation methodology used herein. The securities mentioned in this publication may not be eligible for sale in some states or countries. Espírito Santo Investment Bank Research does not accept any form of liability for losses or damages which may arise from the use of this report. Please note that investing in any non-U.S. securities or related financial instruments discussed in this research report may present certain risks. The securities of non-U.S. issuers may not be registered with the U.S. Securities and Exchange Commission or subject to regulation in the United States. Information on such non-U.S. securities or related financial instruments may be limited. Foreign companies may not be subject to audit and reporting standards and regulatory requirements comparable to those in the United States.

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