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‘A Pole Star’

We initiate coverage on STARHEALTH with a Buy rating and a Mar’23 TP of Rs1,135 (+25% upside). Our TP implies a valuation multiple of 47x FY25E EPS and a FY25 P/GWP of 2.9x. Our high-conviction Buy on Star Health is underpinned by three factors: 1) health insurance industry is still in its infancy - we expect heady growth rates of ~20% in the next decade; 2) Star Health’s dominant market share (>3x nearest competitor) in the sticky retail sector offers network effects - trio of hospitals, customers and agents feed off each other in a virtuous cycle. Sub-scale competitors will struggle to outdo this moat; and 3) we expect margin gains with scale. We estimate Star Health’s GWP to see a 25% CAGR through FY25. Unit economics are extremely favorable – we expect ROE of 18%+ as claims normalize in a 66-67% band (after Covid-19 hump), capping combined ratio at 94-95%. We apply a DCF model to arrive at our Mar’23E TP of Rs1,135. We are of the view that investors should not be deterred by high valuations, which are rightfully anchored to STARHEALTH’s nearly unassailable position in a high-growth industry.

* Heady industry growth rate of ~20% for a decade or more: The Indian retail health insurance industry is well-slated for a strong ~20% premium CAGR in the coming decades as penetration within the total addressable market (TAM) of 400mn continues to improve from the current abysmal level of ~12%. Increase in sum assured to catch up with medical inflation, age cohort pricing gains and re-pricing will likely account for half of the premium growth.

* Dominant position in retail health protected by flywheel effect: Star’s relative market share gap (>3x share than next competitor) in the profitable retail business is less appreciated. The relative size offers a flywheel effect to the interlinked levers of network hospitals, customers and agents. Hospitals and customers feed off each other’s ease of availability, and agents are most productive with market leaders. We estimate that this moat is tough to negotiate – calling for an upfront and disproportionate investment in agents and incentives, unfavorable terms to accelerate network of hospitals, and above all, destructive pricing to port existing/new customers. STARHEALTH’s execution prowess has been flawless. Its 31% share in retail health and 16% share in overall health have come against established PSU behemoths (for which the profit motive is secondary) and well-entrenched private multiline insurers. If at all, future execution risks are lower with size and scale on its back. STARHEALTH is now a ‘pole star’.

* Scale will invariably lead to more margin gains, and better margin control than peers: After reaching a threshold, STARHEALTH’s scale can help drive hospital traffic in exchange for better rates - keeping claims cost - the largest expense item - in check. Likewise, the company will have levers to tweak renewal commission rates and will benefit from a natural leverage to opex. All of these levers power the company to maintain the combined ratio in ~94-95% band. It is worth noting that a 100bps improvement in the combined ratio leads to ~250bps improvement in RoE.

* Initiate with Buy and a TP of Rs1,135: We arrive at our Mar-23E TP of Rs1,135 for STARHEALTH using future profit discounting, with PAT rising to Rs14.1bn in FY25E from Rs7.4bn in FY23E. We assume: 1) 12% cost of equity; 2) steady-state combined ratio of 94.3% from FY26E; 3) 16.7% PAT CAGR in FY25-38E; and 4) terminal growth rate of 7.5% for PAT starting FY38. Our TP implies a FY25E P/E of ~47x and P/GWP of 2.9x.

* Key risks: 1) any further damaging wave of Covid-19 can have a material impact on Star’s financials, but increased immunity due to vaccination and natural infection reduce the chance of a severe wave; and 2) being a regulated industry, regulatory risks always remain. However, we see little possibility of any adverse regulatory development in the near- to medium term.

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