PUKPF - Prudential: Compelling Near-Term Setup To Extend The Post-November Rally

2023-03-08 12:36:26 ET

Summary

• With a new CEO at the helm and the China reopening underway, Prudential is poised for a better FY23.
• Beyond the post-reopening earnings recovery prospects, the recent Macau expansion also allows for new growth opportunities, particularly in the ‘Greater Bay Area’.
• The strengthening case for a narrowing relative discount to key peer AIA also supports a valuation re-rating.

Prudential plc ( PUK ) has been re-rated in recent months following the easing of COVID-19 restrictions in China, as the government shifts its priority toward economic growth and stabilization. The significance of this event, along with the reopening of the China-Hong Kong border, cannot be overstated, given the outsized contribution of Prudential's Hong Kong offshore business in the pre-COVID years. So even conservative assumptions of HK-driven new business volumes imply an inflection in the earnings and book value growth trajectory in the coming years.

Also positive is the arrival of new CEO Anil Wadhwani (formerly regional head of Manulife ( MFC ) Asia). A major strategy shift seems unlikely at this point, though Mr. Wadhwani should help the Asia-focused transition, as well as its expansion into digital (via the ‘Pulse’ health and wellness app). The stock also trades at a low-teens fwd P/E (or high-teens trailing P/E) – a relative discount to key peer AIA ( AAGIY ) and a post-reopening earnings recovery scenario. With all signs pointing to more upward revisions to earnings and book value estimates alongside the improved new business outlook in mainland China and Hong Kong offshore, the recent rally likely still has legs.

China/HK Border Reopening to Catalyze the Post-COVID Earnings Recovery

From a significant contributor pre-COVID, Prudential saw its Hong Kong new business premiums ((NBP)) heavily curtailed since 2020, as the closure of the Mainland China/Hong Kong border effectively stopped offshore sales (i.e., Chinese customers purchasing insurance in Hong Kong). Given the offshore contribution was over half of its Hong Kong business, the announcement by China to ease quarantine travel requirements from January 2023 for the two-way border understandably boosted investor sentiment.

While the expectation is for an earnings recovery in the mid to long-term, a more gradual earnings rebound is the most likely near-term scenario based on recent data . In line with this view, I would be hesitant about underwriting a recovery beyond ~30% of pre-COVID Hong Kong offshore new business premiums this year. Depending on the pace of visitor flow and consumer confidence, though, this estimate will be worth revisiting. Beyond the top line, the new business margins will also depend on competition and the category of product sales – a protection-led recovery would mean higher margins, for instance, than savings products.

Macau License Paves the Way for New Growth Opportunities

On the heels of the reopening, Prudential also announced regulatory approval for the extension of its Hong Kong business into Macau. Per management, the branch expansion will begin with life and health insurance solutions through its digital channel before a more meaningful physical buildout down the line. Importantly, the entry into Macau, a license that Prudential had been lobbying for a while now, allows it access to an underpenetrated market with an aging population. So even though the overall life and health insurance opportunity is smaller than in Hong Kong, the growing demand for private healthcare access and solutions could lead to meaningful revenue opportunities over time. It also allows the company to catch up with key competitors AIA and AXA ( AXAHY ), both of which have already built a presence in the market.

Understandably, the stock traded sideways post-announcement of the Macau license – the incremental revenue potential here is far outweighed by the tailwind of the Hong Kong border reopening. That said, the market might be underestimating the Macau impact within the broader context of Prudential’s positioning in the ‘Greater Bay Area’ ecosystem. Comprising nine mainland municipalities and two special administrative regions (Hong Kong and Macau), the area already spans an ~87m population and >10% of China’s GDP; as the ‘Belt and Road Initiative’ gains momentum, expect the market potential to expand further beyond South China as well.

A bigger footprint in China’s Greater Bay Area offers growth opportunities like the ‘Insurance Connect’ scheme , which will allow mainland Chinese customers to access Hong Kong or Macau health and critical insurance policies benefits. Thus far, the rollout of initiatives like direct health claims settlement at Shenzhen-based public hospitals with Hong Kong and Macau insurers is positive. Going forward, expect a further expansion of the scheme across the whole of the Greater Bay Area, with the buildout of more service and after-sales centers presenting ample new growth opportunities for insurers. Through its Macau license, Prudential is well-positioned to tap into new revenue streams, supporting its earnings outlook and valuation over time.

Compelling Near-Term Setup to Extend the Post-November Rally

Prudential’s outperformance vs. the broader market since the easing of China’s zero-COVID policy in November and subsequent reopening of the mainland China-Hong Kong border seems justified, given the incremental earnings opportunity from a pending recovery in the offshore insurance market. Of note, the Hong Kong offshore business has been a significant contributor to new business volumes historically, so even a gradual volume recovery would entail sizable earnings revisions going forward. Plus, Prudential’s recent Macau license approval adds yet another new market opportunity in a fast-growing and underpenetrated region. Finally, the new CEO should catalyze the strategic roadmap, along with group-wide simplification efforts and a bigger push into the digital channel. All in all, there is a strong case for the AIA valuation gap to narrow; successful execution should catalyze a re-rating over time.

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