PICC P&C:Walking wounded

Foiled by non-operational challenges; downgrade to U-PF

Our preference for P&C over life remains unchanged for its betterprofitability in a low rate environment. Yet it’s frustrating to see PICCP&C hurt by non-operational issues. VAT reform is set to weigh on thecombined ratio. But the damage isn’t as big as its decision to fund PICCHealth, a loss-making unit under its parent. The profitable P&C seems tobe called upon again to support unrelated causes. We cut EPS and TP (toHK$13.4 from HK$19.5) to reflect tougher underwriting and potentialneed for further recapitalisation in sister companies. Downgrade to U-PF.

Fundamentals better than life

Fundamentals for P&C have been under pressure as non-auto claims are setto surge this year on more catastrophes. While combined ratio for auto hasbeen stable following pricing reform, it could experience more swing in thenext two years with surge in claims. But still, we see better profitability andearnings visibility at P&C and our preference for it over life remains.

But clouded by non-operational issues

The challenges confronted by PICC P&C are rather out of its own control. VATreform, effective in May nationwide, is negative to premium recognition,investment income and combined ratio. It’s difficult to quantify the impact onthe last one on lack of clarity in expense deductible. While we do expectindustry lobbying for leniency, it’s not unreasonable to assume some hit.

Risk of national service

The biggest frustration to investors is its recapitalisation of PICC Health, aloss-making unit set up by its parent. Recalling its investment in Huaxia Bankearlier this year, it makes one wonder if the profitable P&C business is calledupon again to support unrelated causes and faces more such risk down theroad.

Downgrade to U-PF from BUY

We give zero value to the health and life operations in setting the TP of PICCGroup for their lack of profitability and apply a 25% discount at the end toreflect the need for capital. And we are now obliged to extend the samediscount in valuing PICC P&C. We cut EPS at both PICC P&C and PICC Groupbut roll forward to 17CL valuation. TP of former goes down to HK$13.4 fromHK$19.5 (downgrade to U-PF from BUY), and group down to HK$3.2 fromHK$3.55 (U-PF maintained).