0662.HK - Asia Financial Holdings

[RVP]

Asia Financial Holdings (0662.HK) is a family-owned insurance conglomerate based in Hong Kong. Before diving into the details, I should note that this is not your typical HK cash box/ overly compensated management value trap. Management has treated shareholders fairly over the years and has operated their insurance subsidiary at a very high level (think Berkshire-like levels).

 

As a result, book value has compounded at mid to high single digits over the past decade - all without the use of any meaningful debt. The rate of compounding is even more impressive if you include dividends and special dividends paid out over the years. It gets even better when you consider that roughly 36% of their total assets are recorded at cost and retains the bulk of their earnings (and thus shows no benefit via BV or income statement).

 

Their wholly owned subsidiary, Asia Insurance, is a top 10 P&C insurer in HK that writes relatively short-tail risks (<5 years) across a broad and well-diversified spectrum of end-clients in various industries. The results here have been eye-popping, with CR <90% since 2007. Even if you add back every single expense line item reported outside insurance division, CR hovers <100%.

 

On the investment side, it can be categorized via 3 buckets:

1. Mark-to-Market - HKD$4.1B (30% of assets - blue chip listed equities, IG bonds, funds)

2. Recorded at cost - HKD$4.9B (36% of assets - JVs, associates, unlisted equities, loans)

3. Cash and cash equivalents - HKD$4.5B (33% of assets - cash, re-insurance receivables (9% of assets))

 

On the liabilities side you have a total of HKD$4.2B, of which HKD$3.4B are insurance reserves.

 

You don't need a calculator to see that the company is asset rich and overcapitalized.

 

On a blended level, the assets are currently earning roughly HKD$350M per annum, which implies a very mediocre 2.5% ROA. However, roughly 69% of these assets are currently earning a pittance and/or not being reflected on the income statement. In other words, the reported ROAs and ROEs that the computers pick up will not be accurate - namely because a big chunk of earnings power will only be realized upon monetization of assets that are recorded at cost, as well as higher rates should cash be deployed.

 

I won't do an individual breakdown of the assets recorded at cost here, but if you do the work, you'll probably quickly conclude that the assets they own are high-quality and very likely worth multiples of what they're carried on the books. Just as an illustration - the HKD$1.1B sale of their 16% JV stake in Hong Kong Life (life insurance) fell through last year, but is carried on their books at roughly HKD$100M. Yes that's not a typo - it's carried at less than 1/10th.

 

For all this, the market is valuing the entire business at a mere 0.40x reported BV (likely much less if assets recorded at cost are monetized). This is usually the type of valuation that is attached to an insurer in distress, or with suspect assets/ liabilities. None seem to be the case here. The asset side is high quality and understated. The insurance business relentlessly posts underwriting profits year after year, and insurance reserves have always been conservative without any concentration risk to any single customer/ industry.

 

Common sense dictates that profitably growing insurers with bullet-proof balance sheets and talented management teams should not trade below 1x BV, let alone 0.40x. 

[Spekulatius]

So Asia Financial does not mark their assets at fair value, like most Hk companies do? In HK, fair value gains are not taxed, so there is no reason not to do it. It seems based on a quick look that Asia Financial values their strategic investments (for the sake of income / Dividends) at cost and their trading assets at fair value., is this correct?

[RVP]

So Asia Financial does not mark their assets at fair value, like most Hk companies do? In HK, fair value gains are not taxed, so there is no reason not to do it. It seems based on a quick look that Asia Financial values their strategic investments (for the sake of income / Dividends) at cost and their trading assets at fair value., is this correct?

 

That's correct. I would add that they typically don't have any hard distinctions as to what constitutes strategic investments/ trading assets. Their strategic investments can and have been monetized if they think the value is right (vs perpetual holding period for many other HK companies), and likewise their trading assets can be held longer term if they see value building up nicely. Key is that the strategics (mostly private investments) becomes increasingly disconnected with fair value as time goes by, in a similar way that Berkshire's private operating companies do. 

 

[BroKon]

I own this one too, and while I agree with most of RVP’s analysis and definitely with his or her conclusion that its cheap, I have a few additional comments.

 

1. In 2018 they revalued the vast majority of their unlisted equities and booked a gain of 2.4bn HKD, so there should no longer be much hidden value there.

2. From my interpretation of their IFRS 9 disclosure the fair value of the JVs is about 1.47bn HKD more than where it is booked (at net asset value), most of that, I have to assume, is from Hong Kong Life, which RVP discusses (although I still struggle to understand why anyone would have bid over 11 times book for a life insurance company).

3. I think you can also add 1.39bn HKD to book for PICC Life, based on its embedded value using a 10% discount rate.

 

Putting above together you get a share that trades at 0.34x to my calculated book based on a 4.18 HKD price.

A few other things maybe worth mentioning:

1. The company bought back 4% of their outstanding shares in 2016 for an average price of 4.47 (substantially below year-end book of 7.19). Since then they have been disappointingly shy about buybacks. They have, however, become more aggressive recently into what I assume is a motivated seller (bought 1.1% of outstanding shares since end June).

2. There appears to be a motivated seller(s) both in August and this month. Two potential reasons for this I can point to are both linked to the HK protests: CEO Bernard Chan is also the Convenor among the Non-official Members of the Executive Council of the HKSAR since 1st July, 2017, and has also been linked to the succession to Carrie Lam (which he has said he would refuse); secondly insurance claims related to the protests have reportedly reached 600m HKD (although my understanding is that when the government denoted them as riots a lot of the future coverage lapsed, but government might re-intervene on that).

3. The company owns more than one yacht (I guess it could be worse and they could own a few private jets), booked under PP&E. If anyone has a good explanation for why they are needed I would be interested. The only other potential example I found of the family owners/managers not acting in best interest of shareholders was in 2016 when during the buyback they bought over 11m shares from one of their resigning directors at 4.80 (pretty much the high of the year). I am not sure you can draw too many conclusions from the above facts and as their director’s remuneration policy seems very reasonable, I am willing to give the family the benefit of the doubt on both.

4. In addition, there are a few cross-holdings by the various family members (everyone is related to Chin Sophonpanich who founded Bangkok bank), including Bangkok Bank, and Bumrungrad; also the JVs are generally all owned by the same corporate partners. Pretty normal for a Southeast Asian corporate, but if anyone has additional colour here about potential conflicts please share.

5. As RVP corrects for above, their official combined ratio is flattered as they only attribute underwriting expenses, ie allocate a very low implied administrative expense ratio of 7.3%.

 

Finally, while this is very cheap vs book, like a lot of these family owned investment holding companies, they always seem to stay cheap (I also own E-L financial along this thesis) - until that is, one day they don’t. At current valuation, this one seems cheaper than most.

 

[RVP]

Appreciate the additional color and refinement of the thesis BroKon. Your comments are spot on and obviously you've done some good work on this name. Some additional points:

 

- Regarding revaluation of their unlisted equities in 2018: There is likely still some good value hidden there. Besides PICC life, BBL Assets (10% owned) looks very undervalued. BBL is the third largest mutual fund company in Thailand with roughly USD $20B AUM (as of 2018) and fastest growing among the top 3. It's carried on the books for HKD$375M. Unless BBL is loaded with debt (they're private so can't determine for sure), its cheap any way you slice it vs other asset managers around the world. If I'm not mistaken, the carrying value is based on book value, which is no way to value asset managers who are by nature asset-light.

 

- Regarding their JVs: I think there is fat value and optionality embedded in their stakes outside of HK Life (which I agree was bid very pricey). All are good assets that don't require much capital to run (besides the reinsurance biz) and have good industry position. On a forward looking basis, the most interesting piece here is Avo Insurance (51% owned). They recently were the first and only P&C insurer to receive a digital insurance license in HK, which will allow them to begin selling direct to consumer. This additional sales channel is attractive, given 95% of Asia Insurance (their wholly owned P&C subsidiary) is sold via brokers/ third-party distributors. Avo's 49% partner Hillhouse Capital is a well known PE/VC firm who were early investors and has ties to Tencent, JD, and Alibaba. I highlight this partnership because it's very possible Avo leans on the digital knowledge/ experience of Hillhouse to scale quickly and effectively. There is very little value (if any) ascribed to Avo in the books currently, but the pieces are all in place and there's real potential.

 

- Regarding management integrity/ social connections: nothing to add except that their robust connections (particularly in SE Asia) gives them potential access to sweetheart deals that many other investors would not come across. For those interested in learning more about management culture, I recommend watching some of CEO Bernard's interviews, especially those relating to succession and teaching his children. My general takeaway is that the culture is conservative and intact.

 

- Regarding HK insurance landscape: there has been talk on this board of a "hard market" in insurance, and this is likely even more exacerbated in HK with the ongoing protests. BroKon makes a good point to highlight some of what's happening on the ground. In the short term maybe underwriting profits get hit via increased claims, but my guess (ironically) is that this is a good environment for Asia Financial. They have tremendous liquidity to put to work, and given the rather short-tail nature of their policies, their new policies will likely command much better pricing as well as increased demand (few businesses probably want to operate in HK right now without adequate insurance).   

     

[BroKon]

Thanks RVP, I hope you are right on BBL and Avo. We can agree they aren’t overvalued (a quick look at JVs on a dividend yield basis, corroborates that). I also strongly agree with you that the value of the family connections is underplayed.

Only thing that bothers me is if this is as cheap as we think, why aren’t they continuing to buy more shares. With their current cash pile they could easily buy 25m shares and still be more conservative then at 2018 year-end.

 

[BroKon]

Well the company finally came in to buy some shares today, will be interesting to see if they are only interested just below $4.00 or whether this will be a regular event for the next few days.

[RVP]

They have plenty of ways to win. Buybacks, monetization of hidden assets, continued growth of the insurance biz, acquisitions, etc. Because they are fishing in ponds that are generally less competitive (HK & Southeast Asia) and because they target high quality businesses with multi-decade staying power, I'm not certain buybacks are necessarily the best use of capital. They've got a long runway for growth and their small base increases their odds of deploying capital and substantially moving the needle.   

[RVP]

Providing update:

 

Business continues to perform well (84% combined ratio, 98% self-adjusted). Insurance business had limited impact from HK protests, and management says minimal direct impact from COVID-19 in terms of claims. There could be disruption in parts of the group's client base, which may affect amount of future premiums written.

 

Book value has increased ~11% YoY, and cash balance has swelled to roughly $3.4B (virtually the entire market cap). Their overcapitalized/ defensive posture is Berkshire-like, perhaps even more conservative.

 

Profitable, growing insurers with a high-quality investment portfolio and capable management should not trade at 0.34x book. Apparently the market thinks otherwise.   

[Cicero]

Common sense dictates that profitably growing insurers with bullet-proof balance sheets and talented management teams should not trade below 1x BV, let alone 0.40x.

 

Preface: I do find this not uninteresting and I do believe it is undervalued.

However I am not sure I agree that 1x BV as the right fair value yardstick:

 

1. They don't earn their cost of capital. Return on equity is about 4%, return on incremental capital is worse

2. It's a controlled company and that in itself warrants a discount I think. There is a bit of history in Hong Kong of take-unders of controlled companies when trajectory turns favorable (Hopewell being a good recent example)

3. Annual report is fairly "tick the box" template. Hard to understand from the document what is going on with the business operationally. I would take away from this that public shareholders are pretty low on the priority list

4. In the past 25 years - with the exception of a few months in the summer of 2006 - the company seems to never have traded at book. Average seems to be more between 0.5-0.6 and highs around 0.7-0.8

 

Few bits and ends:

a) there are a few companies in Hong Kong that own junks/ boats for client entertainment purposes. Not clear to me how that would be relevant to Asia Financial, but it is more common than one would think.

b) HK Life: life insurance is currently a good business in Hong Kong, because mainland Chinese customers use the life insurance policies to circumvent the foreign exchange controls and get money into hard currencies. There are plenty of mainland Chinese companies who want to get into the business and getting a new license is not easy and takes a lot of time. Buying an existing company with the license is much easier. Hence the large spread between book value and market price I think. I would not infer from this that Asia Financial's portfolio is generally massively undervalued. It's a pretty special case in my view

[BroKon]

Thanks for the input Cicero.

 

Its a fair point on ROE, but the closing of the discount to a more normalised 35% discount, after HKFRS9 is implemented and corrects some of the undervaluation, should provide more than the additional return required for investors.

 

I think you are being a little harsh on the annual report, I have seen way worse examples, and I also think you can take a little comfort from the shareholder roster, that they will at least have to consider minority shareholders.

 

And yes that was my running assumption on the boats, but I was a bit taken aback by how they called them "yachts".

[RVP]

Great points Cicero. To give you the short answer -- this is not one of those cases where there's valuation gaps on assets that have been recorded to perfection, and you need to whittle down your NAV accordingly.

 

I think 1x reported BV is reasonable (and conservative) because the assets are for the most part liquid, growing, high quality, and easily verifiable. The ones that are not liquid, and which are categorized as long-term interests, are recorded at amortized cost (which is likely far below fair value). There's no indication the liabilities are under-reserved, and they've historically been overstated. The underlying business is also relentlessly profitable and continues to throw off cash. If you're skeptical of asset value (like me), you can try to figure out the underlying earnings power of the business and investment portfolio, though it'll take a bit more work. I think you'll reach a similar conclusion, even after applying a 10% discount rate.

 

For the longer answer:                 

 

1. Regarding ROE/ ROIC, I agree that it's not optimized for peak efficiency. I don't think that's a bad thing. It increases their durability to handle shocks, while preserving optionality to snap up great opportunities as they've done in the past.

 

Because of a huge excess cash/bond pile currently earning a pittance, and some earnings accruing on the associates/JVs/equities level, returns are going to look lumpy on an accounting basis. It doesn't mean that value isn't being created. Though a rough proxy, book value has increased at a roughly 8% clip in the past decade, and this is probably understated since it's after dividends and some stakes are recorded at cost. This is pretty good considering they don't use any leverage (besides insurance float), and there's no upward "fair value adjustments" in bubble-like non-liquid assets like what you see in a lot of HK property companies. 

 

2. In general, I agree that some discount to controlled companies/ conglomerates may be warranted, but because of capital allocation risk, not take-under risk. It's not that easy to privatize a company in HK. You need at least 75% of the public float (not including insider/ family shares) to approve, and no more than 10% can vote against. I've looked at several take-under situations in HK over the years, and in my opinion the offers are not usually as bad as how the media portrays them. In cases like Hopewell, yes you'll see huge discounts to book value, but that's because BV is usually grossly inflated via usage of very low cap rates. If you try to isolate the recurring cash earnings stream and apply a more reasonable discount rate, it's often not that bad.

 

3. The disclosures could definitely be improved (like many other HK companies), but I think enough information is provided to form a rough appraisal of intrinsic value. And in my opinion, that appraisal is probably going to end up on the low side, because they're rather conservative in their reporting.

 

I disagree that public shareholders are low on the priority list. It's hard to understand (hence the opportunity) because there are many different businesses under one umbrella, and the accounting standards aren't able to fully capture the inherent earnings power/ intrinsic value in a straight-forward manner. I don't see any indication that they're intentionally trying to mislead shareholders in any way. The compensation is not excessive, and when there's an event where value is crystallized and appear on the books, they've historically been rather shareholder friendly via large special dividends and buybacks.   

 

4. The company rarely trading at book is, in my opinion, a function of its relatively small size and pretty wide/ diverse holdings that don't lend themselves to simple automated analysis. Historically it looks like the discount narrows around monetization events. This, of course, should have no bearing on the underlying value of the business. Today, their asset base and equity is getting considerably larger (~US$ 2B and $1.3B respectively). Given their discipline and ability to compound value, they're going to fall into more and more radars. In fact, they will be added to the MSCI HK micro cap index end of this month. As following increases, it would not be surprising if the historical discount to NAV shrinks over time, all else equal.   

 

Not much to add regarding the boats/ entertainment expenses, except it's not material enough to make much difference in my opinion.

 

Agree completely that the HK Life price tag is economically irrational. It's recorded at cost (~HKD$100M), so no need to worry it will cause impairment to BV. And certainly not using that case to infer the rest of the portfolio is massively undervalued. 1x BV doesn't account for any potential mark-up, if that's the yardstick you choose to use.

 

However, I will say that it's not too hard to see certain other parts of the portfolio rather undervalued just based on reported figures (or lack thereof) and basic understanding of the stake(s).   

[Cicero]

Thanks BroKon and RVP. You field some good points. RVP on your points:

 

1. Apologies I have not looked at the historical ARs in a lot of detail, so maybe this gibberish, but isn't a good portion of the increase in book value driven by fair value adjustments of equity holdings? Last year for example they wrote unlisted equity investments at fair value up from HKD 3.1 Bn to 4.1 Bn

2. I appreciate the mechanics in Hong Kong and I agree that they offer some protection (given that they are incorporated in Bermuda there are some additional protections there as well). The scenario I am worried about is "share price goes down for whatever reason, majority makes a takeover offer at an attractive premium to current but at a huge discount to fair value". I agree that many HK real estate businesses mark their properties at unsustainable levels and deserve to trade at a discount to book. In Hopewell's case I find the timing rather curious given some of the plans on redevelopments, but that is a different story

3. Did you or BroKon talk to management? Are they open to meetings?

4. The point on MSCI micro is an interesting one

 

I'll do some reading on this name; I am intrigued :)

 

[BroKon]

Well here is some more reading for you, a profit warning they just issued: https://f1020179-7def-4e52-a364-9f60a5a24700.filesusr.com/ugd/b4d5f7_7d0cdb38846b4e74a271034a4141212e.pdf

 

Drop in asset value of 10% seems pretty much in the ball park, although the net loss expected is much harder to reconcile (at least I couldn't when I took an initial run at it), unless they are talking about their comprehensive income.

 

In terms of talking to management, they didn't come across as very open at all, but I guess like everything it depends on the AUM behind you.

[RVP]

Re: the profit warning, I'll try to give it a shot:

 

As of YE 2019 (all in HKD), the financial assets measured at fair value through profit or loss was ~$1.2B, of which ~$1.1B was in equities and investment funds. S&P 500 and Hang Seng Index dropped roughly -21% and -17% in first quarter. Let's call it a -20% drop on their $1.1B exposure, which would be about -$220M. 

 

Holding the Interim 2019 income statement steady, we had roughly $75M underwriting profit +$79M div income and +$49M interest income +$32M from JV/associates = $235M. Subtract $59M for operating expenses and financial costs, you're left with $176M. Subtract -$220M from the financial assets losses above, and you arrive at an expected $-44M net loss before tax. 

 

For the asset value, I can easily ascribe a -5% mark-to-market impairment from the financial assets above, Bumrungrad Hospital, and Bangkok Bank. The remaining -5% might be from write down in PICC life.

 

YE 2019 embedded value for PICC life was roughly $4.4B (at share), vs a recorded value of $3.4B on Asia Financial's books. Based on prelim Q1 figures from PICC, core capital at PICC life has actually strengthened, so I don't see any red flags there. Lower interest rates will be headwinds for life insurers, but if what I expect is accurate regarding 50% of the asset value write-down stemming from PICC life, I think it's just Asia Financial being conservative as usual.   

[BroKon]

That's embarrassing, I read it as a net loss of 244m. Ignore me. FWIW my maths was similar to yours, clearly my reading skills need some work though. That will teach me to skim announcements on my phone.

[RVP]

Interim results out:

https://www1.hkexnews.hk/listedco/listconews/sehk/2020/0827/2020082700657.pdf

 

Strong underwriting results, and new business wins at their core Asia Insurance (which is remarkable considering the challenging environment for many businesses in Hong Kong).

 

Investment portfolio had a very difficult period, with mark-to-market impairments primarily from Bangkok Bank, Bumrungrad Hospital, and PICC life. None are likely to be permanent IMO. The PICC life (private) markdown may not be accurate, since results have not been posted. They are probably just being cautious as in the past. 

 

Other various notes:

 

- Their Shanghai property development associate seems to be having strong business momentum, and is starting to grow into a not so insignificant portion of assets.

 

- Bank Consortium Holding JV (HK pension & asset management) remains healthy

 

- Avo insurance progress (the first and only digital general insurance license in HK) is very generally alluded to, seems to be in scale up mode. Have a partnership with Two Sigma to develop:

https://coverager.com/avo-insurance-partners-with-two-sigma/

 

Perhaps they should IPO Avo and potentially ride on the coattails of LMND  ;)