LIC | Will shares catch up with its true valuation?

In first trades on listing, shares of the Life Insurance Corporation (LIC) of India traded at Rs 872 against issue price of Rs 949. At this price, all investors — including policy holders, employees, and retail investors who got shares at a discount of Rs 40-60 per share — lost money.

It would appear that someone started buying large quantities of LIC shares thereafter. It reached a high of almost Rs 919 per share. In the first 20 minutes, 20 million LIC shares, about 10 percent of IPO, got traded.

Despite a firm market the entire day, LIC remained subdued trading at a near fixed price of Rs 875 for most of the day, and closed at Rs 875.25.

Soon we will know details of who sold and bought during the day. It looks quite likely that a good chunk of policy-holders, employees, and retail investors used this opportunity to exit.

Was It Enough?

LIC’s paid up equity capital is Rs 6,325 crore. The Government of India initially wanted to sell 5 percent of LIC’s equity (316.2 million shares) at about Rs 2,000-2,250 per share with a valuation of about Rs 15 lakh-crore.

Tepid feedback from foreign investors, brokerages, and other advisers made it scale-down the LIC IPO to 3.5 percent of its equity (approximately 220 million shares) at a valuation of about Rs 6 lakh-crore to raise about Rs 20,500 crore.

There was not much enthusiasm for LIC’s offering. The anchor book was barely subscribed with foreign investors largely staying away. The LIC issue was kept open for five days with banks accepting bids even over the weekend. Yet, the issue got oversubscribed just 2.95 times.

LIC’s Embedded Value

LIC’ balance sheet exceeds Rs 40 lakh-crore, higher than the AUM of all the mutual funds of about Rs 38 lakh-crore, with assets attributable to the shareholders exceeding Rs 15 crore.

The value attributable to shareholders is fundamentally assessed by the metric of the earnings per share (EPS). However, in the case of life insurers such as LIC, another method of valuation — the embedded value — is also used. The embedded value, a complex method based on various assumptions about future, equals the present value of future profits together with market value of net assets.

Actuaries assessed LIC’s embedded value at about Rs 5.4 lakh-crore. LIC’s embedded value was only Rs 90,000 crore in FY2020-21.

No one really understands embedded value well. LIC’s DHRP discloses many risk factors associated with its embedded value, giving an impression that even the LIC management was not fully confident about its assessed embedded value.

How to Value LIC Right?

LIC’s DHRP disclosed its EPS averaged Rs 4.47 in three preceding years. Further, the EPS was only Rs 2.38 in the six months of FY 2022.

The Price-to-Earning (PE) ratio, the most trusted conventional measurement of value, for LIC earning Rs 4.47 per share, works out to 212.3 per share for price of Rs 949. The PE ratio of other life-insurers range from 81.46 (for SBI Life) to 94.26 (for HDFC Life). Though their PE ratios are also high, LIC’s was simply a huge leap of faith. At a PE ratio of 90, LIC’s share price would have had to be only about Rs 400 per share.

LIC earned a net profit of Rs 2,971 crore for its shareholders in 2020-21. In 2021-22, it earned Rs 1,672 crore of profits in first nine months. LIC is unlikely to report profits exceeding Rs 3,500 crore for the year 2021-22.

A profit of Rs 3,500 crore amounts to an EPS of Rs 5.54 per share. Even if 100 percent profits are distributed to shareholders, they will get an investment yield of only about 58 paise per share — which is hugely disappointing for any investor. For giving investors a modest dividend yield of 2 percent, LIC share price should be about Rs 275 per share.

Profits To Justify High Valuation

Can LIC generate super profits for shareholders in the future to justify higher valuation?

The DHRP informs that LIC generates much lower returns on its AUM. In FY21, LIC’s gross yield on life fund at 8.3 percent was the lowest among the first six life-insurers with others earning 8.6-9.9 percent. Net returns, which is not publicly disclosed, might not be exceeding 1-2 percent.

SBI Life earns a net interest margin exceeding 3 percent, and is still valued at 15 times the EPS. LIC’s investment record and policies does not inspire confidence that it would be able to earn such investment returns.

A much lower market valuation is assigned to PSU shares. Looked at from any time-tested valuation methods, LIC’s right share value does not seem to be exceeding Rs 450-500 per share.

Share Price Catch Up

LIC share price is likely to drift lower to catch up with its fundamental value. How long does it take will depend upon whether free market operates or some institution(s) keep propping up the price.

Subhash Chandra Garg, currently Chief Policy Adviser, Subhanjali, is former Union Finance Secretary, and author of The $10 Trillion Dream. Views are personal, and do not represent the stand of this publication.