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Profitability Peaking For Medibank Private?

Australia | Nov 14 2016


While health insurer Medibank Private has flagged initiatives to improve customer experience, brokers suspect profitability is at the peak of the cycle.

-Could quickly become a single-digit growth stock when cost reductions end
-Management cautious about investing to change negative experience and leakage
-Stock considered reasonable value but lacking positive catalysts


By Eva Brocklehurst

Health insurer Medibank Private ((MPL)) has guided to FY17 health insurance operating profit for the first time, suggesting that this will be broadly in line with FY16. Brokers calculate this equates to around $490m. Meanwhile, growth in premium revenue for the first four months of the year has been below expectations, at just 1.3%.

Management has acknowledged top line growth is slowing and inroads are being made to its market share, outlining a number of initiatives to improve customer experience, to take effect in the December quarter.

Morgans believes the company was coy at the AGM about trends in claims but concedes this is a difficult area on which to obtain consensus. At the very least, recent industry commentary suggests claims utilisation is neutral to positive. This provides some confidence in the company's operating profit guidance. While further cost reductions and continued low claims utilisation may provide a near-term tailwind, Morgans envisages current industry profitability as a peak in the cycle.

The broker remains of the view that if Medibank Private cannot restore top-line growth in the first half, it could quickly become a mid single-digit growth stock when its cost reduction program ends. In that scenario, the broker believes the current price/earnings multiple for FY17 forecasts of 16.5x may be hard to justify.

Morgans acknowledges upside risks to its view on the stock could come from management being able to deliver more on cost reductions than it currently expects, or by reversing market share losses.

Industry data supports Macquarie's long-term net margin assumptions of 6.5%, a key sensitivity for the stock. Macquarie's base case price target of $2.75 assumes a net margin of 6.5% from FY19 and beyond. This is slightly below the rate achieved by competitor BUPA. BUPA has now replaced Medibank Private as the largest fund by premium share.

Soft revenue trends are already reflected in UBS estimates. The broker reduces its assumptions for claims growth to capture the more optimistic health insurance operating profit. UBS observes AGM commentary was particularly cautious regarding the investment required to change negative policy-holder experiences and stem a leakage of customers.

Given this backdrop, the broker is not inclined to expect higher net margins in FY18, or adopt a more positive view on the stock, and retains a Neutral rating.

Ord Minnett assesses the company's guidance on insurance operating profit removes the downside to its forecasts. Industry conditions are expected to be similar in FY17 to those of the second half. The company has flagged significant benefits from new initiatives for its customers. In addition to its free dental checks for Medibank Extras customers, new initiatives include all hospital cover members having accident cover and all members now having unlimited emergency ambulance cover.

Ord Minnett remains cautious about the likely benefits from these initiatives, noting that at this stage, the company believes the cost impacts will be offset by other savings. All up, the broker believes, if Medibank Private's assumptions hold up, this should take away downside risk. Ord Minnett continues to find the stock attractive, noting there is no gearing and the claims trajectory appears under control.

In taking into account the operating profit guidance for FY17 and marking to market, Citi lowers its forecasts for earnings per share for FY17 by 5% and FY18, FY19 by 1%. The broker expects slowing premium growth to persist, and estimates the guidance implies a net margin of 7.8%. The margin should benefit from the benefits of savings from the payments integrity program and hospital re-contracting, but the broker expects this to be offset by some normalisation in hospital utilisation rates.

Citi believes the uncertainty around the extent of margin re-investment that the new CEO is willing to undertake has dissipated somewhat. The broker interprets the commentary to suggest Medibank Private does not intend to invest more of its margin in restoring its customer proposition. While the stock looks to be reasonable value, positive catalysts are lacking and Citi will look for further elaboration of the company's strategy at the investor briefing on November 30

Credit Suisse suspects earnings growth will be difficult to achieve. The company has implied a higher expense base, the broker notes, as it is hiring 20% more contact centre service staff by Christmas. With gross margins continuing to be elevated, the outlook for the 2017 price increases becomes more challenging, in the broker's view.

As peers have recently commented on price increases of 4-6% in the medium term, the lower end of this range is most likely, Credit Suisse suspects. The broker's focus is now on regulatory risk, which it believes may limit growth in earnings per share for an extended period of time.

There are two Buy ratings, five Hold and one Sell on the FNArena database. The consensus target is $2.67, suggesting 8.1% upside to the last share price. Targets range from $2.40 to $3.00. The dividend yield on FY17 and FY18 estimates is 4.6% and 4.7% respectively.

Disclosure: The reporter has shares in Medibank Private.

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