• Initiating coverage with a Buy We initiate coverage on Bupa Arabia (Bupa) with a Buy rating as our FV of SAR155.0 implies 22% potential upside. Bupa is the largest and most profitable healthcare insurer in Saudi Arabia with a 43% GWP market share in 1H16. Our Buy rating is underpinned by i) strong growth opportunities; ii) large scale; iii) operational excellence; and iv) upside from investment income. Moreover, lower capital intensity (due to slower GWP growth and high profitability) should enhance free cash flows, dividend yields, and overall value appeal. We view Bupa as an attractive proxy to the Saudi healthcare system. The recent weakness in the stock price provides a decent entry point, in our view.
• We forecast sustainable ROEs of c30% Although we expect GWP growth to slow from its super growth phase in 2014-15, we expect Bupa to deliver an ROE of 30% over our forecast horizon. Improving investment returns should improve profitability, while high solvency ratios could free up capital for dividend distribution. We estimate its dividend pay-out to rise from 25% in 2015 to 52% by 2018. Transfer of public sector insurance (which appears difficult in the near term) or inorganic growth opportunities (M&A or expansion in to managing hospitals) could lead to higher earnings retention, and improve its growth outlook.
• Plenty of room to enhance investment returns Higher interest rates coupled with the reduced need to continue adding to solvency, should free up the company to look for opportunities to enhance investment returns. Unlike banks, the investment horizon for insurance companies is short (healthcare is a short-tail business), allowing them to quickly re-price their investment book. Bupa reported one of the lowest returns on its investment portfolio (0.4% in 2015). We expect it will benefit from higher interest rates and by also selectively adding risk to its investment portfolio, which is currently dominated by bank placements.

Murad Ansari
Shabbir Malik