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Medibank Soldiers On Despite Garrison Loss

Australia | Nov 20 2018

Medibank Private has lost its Garrison Health Services contract, a setback in terms of diversifying away from the private health insurance business.

-Target of doubling health services contribution now challenged
-Excess capital still positions Medibank Private for acquisitions
-Is the market too complacent about medium-term risks?


By Eva Brocklehurst

Medibank Private ((MPL)) has suffered a setback, having lost its contract with the Australian Defence Force, called Garrison Health Services. Garrison formed part of the company's health services division and Medibank provided the ADF with access to medical professionals, specialists and medical facilities.

The company expects -$5m in one-off exit costs in the second half of FY19. Subsequently, Morgan Stanley's estimate of the FY20 operating profit contribution from non-regulated health services falls to around 6% from around 11%.

Ord Minnett suspects the contract may have been won by BUPA, which also operates in this segment, noting that in 2014 Medibank Private also lost the Department of Immigration contract to BUPA. Medibank claims to have provided a competitive offer in the tender process, with no apparent reason for the loss.

The contract was most likely "lost" by Medibank rather than "won" by another insurer, Morgan Stanley asserts, which raises questions around relationship management. Garrison contributed around $30m to operating profit in FY18, out of a total of $47.3m across the health services division.

Ord Minnett believes margins for the Garrison business were better than those for the remaining health services, which it estimates are around 10%. The loss of the contract leaves an even less diversified business, Citi agrees, with regulated Australian resident health insurance now making up more than 90% of operating earnings.

Morgans is annoyed at the loss of the contract. While losing Garrison is not overly material to the main business it does represent a large hit to the operating profits of the smaller "health" segment.

Moreover, despite management stating there is no lost IP from the termination, the broker believes concerns will linger over whether this will affect the roll-out of other health services such as home treatments. Morgans acknowledges commentary that the Garrison contract was run separately and, after six years, the IP from the contract has largely been applied.

Deutsche Bank acknowledges the loss of the contract is a negative, having assumed the ADF would not want the health records of service personnel to be held and managed by a foreign entity, and that Medibank Private had met its contract obligations and expectations. Despite the setback, the broker retains a Buy rating on valuation grounds.

Medibank had a target of doubling the contribution of non-health insurance operating profits by 2020, from the 4.6% reflected in FY16 results, and Morgan Stanley suspects this aspiration is now challenged. The company remains committed to growing the division through acquisitions of in-home care.

Medibank Private guided to two further acquisitions at its FY18 result, which Macquarie calculates could contribute around 2.5% to group operating earnings in FY19. The broker believes further acquisitions are needed to soften the earnings impact of the loss of the Garrison contract as well as the impact of just 2% increases in average prices. Nevertheless, the company has $143m in excess capital which positions it well to acquire businesses and manage claims cost inflation.


In the medium-term multiples appear expensive, given peak margins and the outlook for lower premium rate hikes, in Morgan Stanley's view. While a prolonged benign claims environment provides some support, the broker suggests the market is too complacent about the medium-term risks.

Ord Minnett agrees that significant political risk overshadows the stock, with the upcoming health insurance price renegotiation and potential for government claw-back of recent margin expansion, as well as the likelihood of higher capital requirements. Therefore, it is difficult to envisage the stock outperforming based on these risks and the broker maintains a Lighten rating.

Progress is being made in turning around the business, but Morgans acknowledges the investment thesis is difficult amid the risks to industry pricing from a potential Labor government.

Citi concurs that value in the stock appears to be emerging. Still, given the uncertainty surrounding the impact of Labor's proposed 2% price cap, should it win government, the broker introduces a -10% discount to its target.


Medibank Private generates earnings from a number of related activities that use its expertise in the private health segment. These earnings are bundled into the "health" division and contributed around 8.1% to operating earnings in FY18.

Incorporating the loss of the Garrison Health Services contract from July 1, 2019 and potential headwinds for the insurance business, Macquarie forecasts a 9.3% contribution to operating earnings from this division in FY19. The broker notes only three of the health business units that existed when the company listed in 2014 will remain in FY20. These include travel/pet/life insurance, telehealth services and the health advice line.

Additional units in the segment now include CareComplete, Medibank at Home, Health Concierge, HealthStrong and Home Support Services. Home Support Services is a recently acquired South Australian business for chronic disease management which will be rolled out to the east coast.

FNArena's database show three Sell ratings, four Hold and one Buy (Deutsche Bank). The consensus target is $2.71, suggesting 7.1% upside to the last share price. This compares with $2.95 ahead of the announcement. Targets range from $3.10 (Credit Suisse, yet to comment on the contract) to $2.30 (Morgan Stanley). The dividend yield on FY19 and FY20 forecasts is 5.1% and 4.7% respectively.

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