Concern Over Medibank Private’s Outlook

This story features MEDIBANK PRIVATE LIMITED, and other companies. For more info SHARE ANALYSIS: MPL

-Hospital negotiations critical
-High lapse rates continue
-Expenses a key opportunity
 

By Eva Brocklehurst

Recently listed health fund, Medibank Private ((MPL)), has quickly become the subject of debate among brokers regarding its outlook. While most expect prospectus estimates will be achieved there is growing doubt about just how robust FY16 will be.

Citi backs management's ability to deliver on margins with a large part of the expected expansion coming from lower claims costs. Health insurance revenue may miss prospectus growth forecasts of 6.2% (Citi expects 5.6%) but the broker envisages core profit will come in a little ahead of prospectus. Citi is also confident the company will execute on its strategy to address claims fraud and leakage via improved data mining while negotiating more risk-based outcomes with hospitals. The broker initiates coverage with a Buy rating and $2.40 target.

Central to Citi's argument is the ability to negotiate more favourable contracts with hospitals. The company wants to lead the industry by negotiating more sophisticated contracts with private hospitals rather than the predominant cost-plus basis. Historically, Citi notes, hospitals have had the upper hand in negotiations as consolidation in that segment has increased over time. Still, there is support for a belief that the balance of power could shift more in health funds' favour, as affordability become a significant issue. The broker acknowledges the risk that any stoush with a hospital provider could well become public but believes, generally, hospitals support the push for improved outcomes.

Existing agreements with the two major groups, Ramsay Health Care ((RHC)) and Healthscope ((HSO)) are not due for renewal until next year. Nevertheless, negotiations with Calvary Health Care are unresolved and remain a key point of uncertainty for several brokers.

Citi considers the next catalyst will be the results in August, with an inaugural dividend likely. At that point Australian Prudential Regulation Authority statistics will also be released on the industry for the first time – taking over from the Private Health Insurance Administration Council –  which should allow the relative performance of the business to be determined. On this subject, UBS noted claims growth moderated and margins appeared stable in the latest quarterly industry statistics. Still, the broker remains unconvinced that high lapse rates for Medibank Private are yet to dissipate.

Morgan Stanley does not believe the FY15 results will either surprise or inspire. Top line growth is under pressure and the broker doubts whether meaningful margin expansion will occur. The broker cites rising lapse rates and growth in the lower-premium brands as main challenges. The broker targets a gross margin of 13.5% versus guidance of 13.6%.

The key area of opportunity in Morgan Stanley's view is management expenses, although the broker acknowledges spending is needed to reinvigorate the Medibank Private brand while the major IT revamp should also enhance digital sales and service and data analytics. The broker expects the transition to APRA's capital framework will be smooth but the the government's dividend, IT capex and rise in deferred acquisition costs may require a small sub-debt raising to maintain capital within the targeted 12-14% of premiums. 

On the subject of expenses, Citi agrees there is scant evidence Medibank Private is achieving much in the way of economies of scale but, when viewing expenses on a per member basis, the story is a little better, with Medibank Private having among the lower management costs per average policy, albeit still higher than other large players such as Bupa, HCF and nib Holdings ((NHF)).

Morgan Stanley considers top line growth expectations of over 6.5% are too bullish as the effects of an ageing population and cyclical headwinds mean an aggressive margin expansion story is unlikely to materialise. The broker retains an Underweight rating. The outlook also appears challenging to Credit Suisse. While confident FY15 forecasts will be achieved, or exceeded, the broker believes any FY16 guidance will be indicative of mid single digit growth. The broker cites product downgrades across the industry, increasing competition, the fund's above-industry premium rate increase, the absence of further industry profitability improvements and lower cash rates as all headwinds.

Credit Suisse suspects customers are reaching a point at which, following a decade of above-inflation price increases and reductions to the government rebate, they are closely scrutinising the value in policies. The broker considers the stock fully priced and maintains an Underperform rating.

Macquarie has an Outperform rating, the other "Buy" broker covering the stock on the FNArena database. Macquarie highlight the uncertainty with Calvary Health Care negotiations but expects, in the end, terms will be negotiated which are consistent with moderating claims growth and provide suitable quality outcomes. As claims growth moderates, the broker expects Medibank Private will be able to reduce premiums and still grow margins.

The FNArena database shows two Buy ratings, one Hold (Deutsche Bank) and three Sell. The consensus target is $2.21, suggesting 4.7% upside to the last share price. Targets range from $1.85 (Morgan Stanley) to $2.65 (Macquarie).

Disclosure: The author has shares in the company.
 

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