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Covid 2.0 provisions don’t derail long-term compounder thesis

Covid-related higher mortality and resultant higher provisioning (cumulative ~3% of embedded value till date) is a near-term overhang on HDFC Life. More than 15% growth potential in APE, possibility of improving VNB margins, and >15% RoEV remain safe long-term investment thesis on HDFC Life. Any major correction due to higher provision would be an investment opportunity.

* Regarding covid-related extra mortality reserve. HDFC Life settled >70,000 claims in Q1FY22. Gross and net claims amounted to Rs16bn and Rs10bn respectively. Peak claims in wave-2 (Q1FY22) were 3-4x the peak claim volumes during wave-1 (Q3FY21). Hence, while reserves as on 31st Mar’21 were sufficient to cover claims received in Q1FY22, there is an excess mortality reserve (EMR) of Rs7bn based on current expectations of extra claims ahead. Long-term mortality assumptions ex-covid provisions remain unchanged.

* HDFC Life will maintain a calibrated approach to protection (same as in FY21). Company continues to maintain its stance towards protection with an apparent higher conservatism compared to peers, which was seen in FY21 too. Protection new sales conversion (ratio of number of policies sold to application filed) rate is close to 66%. This conversion rate would gradually improve with: (1) suitable pricing to cover the risk (reinsurers have yet to finalise the pricing of protection post the incidence of second wave); and (2) better medical underwriting (this is clearly taking longer than expected). HDFC Life continues to avoid group term insurance considering the inherent lower margin in that segment.

* All parameters ex-covid reserves remain in line with estimates. Growth in credit protect (Q1FY22 CP NBP was Rs7.3bn vs Rs9.2bn/2.1bn in Q1FY20/Q1FY20), partnerships (proprietary channel NBP share increased to 38% in Q1FY22 vs 32% in FY21; ICICI Securities and TVS Credit were added as partners in Q1FY22), persistency (Q1FY22 13/61M was 90%/53% vs 87%/53% in Q1FY21); VNB Rs4.1bn in Q1FY21 vs Rs2.9bn in Q1FY20 with a VNB margin of 26.2% in Q1FY22 vs 26.1% in FY21. Even if HDFC Life is able to clock only flat VNB in Q2/Q3/Q4FY22, FY22E VNB will still be 6% higher YoY during the current fiscal.

* Maintain BUY. We factor-in VNB margins of 27%/28.5% with APE growth of 18%/18% in FY22E/FY23E for HDFC Life. We expect the company to accumulate Rs58.7bn from new business and Rs45.4bn from unwind (@ 8%) over FY22E / FY23E to reach an EV of Rs358bn by FY23E. We value the stock at 40x new business value of Rs33bn in FY23E to arrive at a target price of Rs823. At our target price, the stock will trade at 4.6x FY23E P/EV. We have factored-in negative operating variance of Rs8bn over FY22E-FY23E.

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