Zhongan Online's 1H23 earnings came in line with expectations. The underwriting business has shown stellar performance, with premiums posting high YoY growth, where the premiums from health, digital lifestyle, consumer finance, and auto insurance were up 15.9%, 52.8%, 52.0%, and 54.3% YoY. Digital lifestyle has risen to become the largest ecosystem. The proportion of premiums from self-operated channels has increased to 30.6%, and the combined ratio has improved to 95.8%. The technology and banking segments recorded loss reduction. Considering the foreign exchange losses on USD-denominated notes, investment income may remain under pressure for the rest of the year. With the central tendency of valuation since 2022 as a reference, we assign 1.8x 2023E PB to derive a target price of HK$27 and reiterate the "OVERWEIGHT" rating.

1H23 earnings came generally in line with expectations.

In 1H23, Zhongan reported gross written premiums (GWPs) of Rmb14.463bn (+37.5% YoY) and attributable net profit (ANP) of Rmb221mn, showing a significant improvement compared to a net loss of Rmb636mn in 1H22. In a breakdown by core business segment: the insurance division achieved a net profit of Rmb447mn, the technology division incurred a net loss of Rmb247mn, and the banking division incurred a net loss of Rmb177mn. Domestic property and casualty (P&C) insurance remains the primary source of value creation.

P&C ecosystems were impressive, with improving underwriting profits. In 1H23, the four major ecosystems, ie health, digital lifestyle, consumer finance, and auto insurance, achieved GWPs of Rmb5,018mn/5,836mn/2,787mn/822mn, accounting for 34.7%/40.4%/19.3%/5.7%, respectively. The combined ratio for domestic P&C insurance underwriting further improved to 95.8% (+0.7ppts YoY) and the underwriting profit reached Rmb532mn, with the combined ratios of all four major ecosystems invariably below 100%.

Significant progress has been made in channel development.

Zhongan Online continues to step up efforts in harnessing the traffic dividends from major online platforms, maintaining an industry-leading position by the number of followers on mainstream short video platforms such as Douyin (TikTok) and Kuaishou. Specifically, it has accumulated more than 25mn followers across over 30 proprietary channels and official accounts on social media. In 1H23, leveraging its data platform and algorithm capabilities, Zhongan continued to increase the deployment of real-time advertising (RTA) models for public domain traffic while optimizing live content and user matching to enhance the efficiency of traffic conversion in both public and private domains. The effectiveness of proprietary channel development is evident, with the per capita daily usage time of the Zhongan Insurance app increasing by 42.0% YoY. In 1H23, Zhongan's GWP through proprietary channels reached Rmb4,425mn (+90.6% YoY), accounting for 30.6% (+8.6ppts YoY) of its total GWP. The number of paying users through proprietary channels reached 6.18mn (+24.8% YoY). The proportion of multi-policy users through proprietary channels reached 54%, with an average of 1.5 policies per user and an average premium per user of Rmb712, an increase of 52.7% YoY. As the proportion of proprietary channels increases, the marginal dilution effect on expenses is likely to become more apparent, and the expense ratio may continue to improve.

The technology and banking segments are poised to turn a profit in 1-2 years.

In 1H23, the technology segment's revenue was Rmb267mn (+22.0% YoY), with a net loss of Rmb247mn. Within the banking division, ZA Bank's net income was HK$152mn (+13.0% YoY), with non-interest income accounting for approximately 25.8%. The net loss narrowed by HK$57mn compared to 1H22, with the net loss ratio decreasing from 191.6% in 1H22 to 131.8%, narrowing by approximately 60ppts. As the business develops steadily, we expect the technology and banking segments to turn a profit in 1-2 years.

Investment income has improved significantly but still faces pressure, with significant exchange losses anticipated in 2023.

As of Jun 30, 2023, the Company's total investment assets amounted to Rmb41.1bn, with cash, bank deposits and funds due from other financial institutions, and fixed income investments accounting for approximately 89.0%. Benefiting from the recovery of the capital markets, especially the strength of the bond market, the Group's annualized total investment yield for 1H23 was 4.4% (vs 1.8% in 1H22), and the annualized net investment yield was 2.4% (vs 2.3% in 1H22). Within the insurance business segment, the annualized total investment yield was 4.0% (vs 0.6% in 1H22), and the annualized net investment yield was 2.2% (unchanged from that in 1H22). Due to increased volatility in the equity market since 2Q23, there is still some pressure on the investment side. Additionally, in 2020, the Company issued US$1bn in USD-denominated notes, and influenced by the strength of the USD, the Company continued to incur exchange losses of Rmb195mn in 1H23 (compared to Rmb549mn in 2022). As of the end of Jun 2023, its outstanding bond principal payable was US$950mn, indicating significant potential exchange losses for the full year. The Company will likely increase its debt repurchase efforts to effectively reduce the impact of exchange rate fluctuations on profitability.

Zhongan Int'l may contribute investment income of c.Rmb3.8bn.

On May 31, 2023, Zhongan International, Zhongan Technology, and Sinolink entered into a subscription agreement, with Sinolink conditionally agreeing to subscribe, and Zhongan International conditionally agreeing to issue additional shares at US$0.66 per share. This matter has received approval from both the Company and Sinolink shareholders in Jul 2023. In Aug 2023, Sinolink invested Rmb320mn in Zhongan International through a subscription for additional shares. After initial closing, Zhongan Technology's voting rights in Zhongan International will decrease to 43.65%, while Sinolink's voting rights will increase to 46.04%. Zhongan International will no longer be a subsidiary of Zhongan Online but will be accounted for as a joint venture. This transaction will result in the recognition of approximately Rmb3.8bn in investment income in 2023.

Potential risks:

Regulation becomes tighter than expected; market competition becomes more intense than expected, product and service innovation iteration is insufficient, growth in ecommerce and pet insurance decelerates, and business expansion falls short of expectations; asset quality of the consumer finance ecosystem deteriorates; proprietary channels fail to maintain their market share and the input of marketing expenses exceeds expectations; sharp fluctuations of stock and bond markets cause the investment income to miss expectations; further strengthening of the USD causes larger exchange losses; investment in technology and banking exceeds expectations while loss reduction falls short of expectations.

Investment recommendation:

Based on the 1H23 financial report and current market conditions, and in accordance with the new accounting standards, we raise our 2023E/24E/25E total revenue forecast to Rmb35.3bn/39.0bn/46.7bn (from Rmb29.6bn/33.7bn/37.5bn), representing YoY growth of 51%/10%/20%, respectively. We tweak the 2023E/24E/25E ANP forecast to Rmb4.6bn/1.4bn/1.7bn (from Rmb1.0bn/1.3/1.7bn). Excluding the impact of Zhongan International's deconsolidation, the 2023E ANP forecast would be Rmb800mn. Correspondingly, we raise our 2023E/24E/25E attributable net asset forecasts to Rmb20.5bn/22.0bn/23.8bn (from prior forecast of Rmb16.2bn/17.5bn/19.1bn), corresponding to BVPS forecasts of Rmb13.97/14.97/16.17 (vs prior forecasts of Rmb11.03/11.89/ 12.98), implying 1.6x/1.5x/1.3x PB at the current price. Considering the healthy and high-speed growth potential of the underwriting business, and with reference to the Company's average valuation since 2022 (which stands at 1.8x PB), we assign 1.8x 2023E PB to derive a target price of HK$27 and reiterate the "OVERWEIGHT" rating.