AIA:No joke,James

Answering the (difficult) questions we have been asked

AIA’s August share price performance reads dismally. Regional macroconcerns weigh on the stock. We set out the effects of interest ratemovements, the sensitivity of earnings to FX moves and speculate howthe broader macro affects the top line. We estimate worst case FY15earnings hit (being, the combination of all 3) could lead to 10-14%. Inthe scheme of things, and longer term, this, in our opinion, is palatable.

The sector will, however, be affected and AIA, as the quality pick, offersreal value. No change to our fundamental view, target unchanged: BUY.

Jokes aside.....

AIA’s recent slide is no joking matter, nor is the fact that investors can nowpick up a quality franchise cheaply. “Quality” in insurance is defined by“discipline” & “margin”, not “growth” & “top line”. We see AIA as a long-termproposition where current regional “noise” has only marginal long-termimpact. A balanced view of the stock, and its earnings, necessarily is a blendof front & back-book: this will dampen the impact of the regional turmoil.

AIA’s sensitivity to interest rate movements

All life-insurers are an exercise in ALM, asset-liability matching: an exercise ininvesting the proceeds of a “promise made” in such a way that the “promisecan be made good” (and the insurer can generate a return & profit, in thecourse of this exercise). Duration is the key: frankly, the longer the better.

WORST CASE: we expect a -25bps move in yield to reduce earnings by 5-7%.

AIA’s sensitivity to FX movements

FX movements do not cause issues at a local level for all (matched)transactions occur in local currency: local issues, however, can generateGroup-level issues – it is the reason for maintaining elevated levels of capital.

WORST CASE: all currencies 5% depreciation to USD reduces earnings 5%.

How does regional instability create issues?

AIA is levered to the growth of the middle class: where a downturn mightaffect the purchase of “discretionary” products. WORST CASE: we estimatesales of ULIPS (and equivalents) in China reduce earnings by 1-2%. Thequality of the back book is/remains strong which, combined with front-bookexpansion driven by penetrating emerging Asia is resulting in increasingreturn on EV. Few other stocks offer this value and scope, in our view. TargetA$62.94, TSR 53.2%, BUY.