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FY23 guidance reaffirmed

Star Health’s Management reiterated its FY23 guidance of ~63-65% claims-ratio and of ~93-95% combined-ratio (CoR), despite the slightly weak H1FY23 performance on account of higher incidences of vector-borne diseases and persistently-high medical inflation. Pricing action, reducing claimfrequency trends (Oct-22 indicative claims-ratio at ~63%) and continued efficient claims management give Management confidence about overall improvement in the H2FY22 claims-ratio. Star Health reported a slightly muted set of numbers in Q2FY23, with claims-ratio of 68.2%, CoR of 97.9% and PAT of Rs0.9bn, logging marginally worse than our estimates. Solvency Ratio at ~195% was robust and the ~8ppts QoQ improvement was despite the Rs2bn solvency-compliant subordinated debt prepayment in Q2. Going ahead, Management remains confident about achieving ~20-22% premium growth in FY24 (H1FY23 premium growth at ~11% YoY, led by Retail growth of ~21% YoY), backed by a combination of price-hikes and volume growth, along with continued focus on Retail and SME. With Covid-led impacts now largely behind, some normalization in medical inflation, increase in number of tie-ups with various hospitals and a strong distribution force, Star Health is poised for a long-term profitable journey in the structurally-attractive retail health-insurance sector. We reiterate our BUY rating on the stock, with revised Dec-23E Target Price of Rs860/share.

* Higher frequency of vector-borne diseases and sticky medical inflation cause a slight miss in a normal quarter: Star Health reported a slightly subdued Q2FY23 with claims ratio of 68.2%, CoR of 97.9% and PAT of Rs 0.93bn, thus missing our estimates. The miss was owing to higher incidences of dengue, malaria and other vector-borne diseases in the quarter, combined with sticky medical inflation. On the premium front, GDPI grew ~11% YoY to Rs 31.9bn. This overall muted growth was in line with Management guidance of withdrawal from loss-making group health lines that saw group health premiums in H1FY23 declining by 49% YoY, reducing group health in the premium mix to ~6% from ~11% in H1FY22. Growth in Retail Health premium was robust at ~21% YoY in H1FY22. The underwriting losses of Rs.131mn were a result of the higher claims incurred that were driven by the monsoon season and the increasing medical inflation. Overall, Star Health’s performance for Q2FY23 was decent. (Exhibit 1)

* Management re-affirms FY23 claims ratio and combined ratio guidance: Despite Star Health’s somewhat poor performance in H1, Management is confident about achieving FY23 claims-ratio guidance of ~63-65% and CoR guidance of ~93-95%. The Management confidence is an outcome of its experience in reducing the claims frequency in October (indicative claims ratio: ~63%), pricing actions and efficient claims management containing claims cost. Remaining conservative for FY23, we build-in claims ratio of 65.8% and CoR of 95.8%. On the growth front, Management is confident about achieving ~20-22% premium growth in FY24, as its pruning of group health in the portfolio mix will be largely done in FY23, and the combination of pricing growth and volume growth should drive premium growth. Going ahead, besides its operational performance, PAT should also see improvement on account of ESOP 2021-related cost (FY22: Rs 0.74bn; FY23: Rs 1.5bn) being completed by Nov-22.

* Solvency ratio at 195% despite Rs 2bn sub-debt prepayment; comfortable capital position: Star Health improved its solvency ratio to 195% as of Q2FY23, from 187% at FY22-end despite calling back the Rs2bn of solvency-compliant subordinated debt. Solvency improvement continues to play out on expected lines, with the Required Solvency Margin (RSM) continuing to see improvement, as high-claims Covid-hit quarters keep moving out from the rolling four quarters, and with the Available Solvency Margin (ASM) seeing growth in PBT (as Deferred Tax Assets have been excluded from the ASM). This 195% solvency is still based on the claims factor; solvency based on the premium factor would have been ~208%. We expect FY23E solvency at ~203%, even with our reasonable growth assumption in H2FY23.This level of solvency should provide comfort and put all talk of raising solvency capital to rest.

* Our conviction in Star Health remains intact: Our high-conviction BUY on Star Health is underpinned by three factors: 1) The health insurance industry is still in its infancy – we expect a healthy growth rate of ~20% in the next decade. 2) Star Health’s dominant market share (>3x of its nearest competitor’s) in the sticky retail sector offers network effects – the trio components, of hospitals, customers, and agents, feed off each other in a virtuous cycle. Sub-scale competitors will struggle to outdo this moat. 3) We expect margin gains with scale

* Minor adjustments to our estimates; reiterate BUY with revised Dec-23E TP of Rs860: Factoring-in the developments in H1FY23, we make some minor changes to our FY23-25 estimates. Our claims & combined ratios have not changed, but we slightly reduce our premium growth numbers. On net, our PAT for FY23-25 has come down by ~1-3%. To bring parity to the valuation methodology with General Insurance peers, we now value STARHEAL using the residual income method. Our residual income valuation approach gives us Dec-23E fair value at Rs860/share for STARHEAL. We reiterate BUY on the stock, with revised TP of Rs860/share (Rs945 earlier), translating into FY25E P/E of 38x and P/GWP of 2.6x. (Exhibits 2-4)

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