Small Caps | Jun 18 2012
– Macquarie has initiated coverage with Outperform on NIB Holdings
– Broker attracted to defensive earnings and focus on capital management
– All brokers covering NIB Holdings rate the stock a Buy
By Chris Shaw
NIB Holdings ((NHF)) is Australia's fifth largest provider of Private Health Insurance (PHI), operating in a heavily regulated and politically sensitive sector of the economy that provides a defensive revenue stream with underlying industry growth of 6-8%.
Macquarie last week initiated coverage on NIB Holdings with an Outperform rating, attracted to earnings growth underpinned by unique industry dynamics and management discipline with respect to capital management.
Market growth driven by population increases and rising health care costs has helped NIB Holdings grow earnings. Government policy, such as the introduction of the Medicare Levy Surcharge, has also driven growth in private insurance in general as participation in the private health sector is being encouraged to lower the burden on the public system.
Management at NIB Holdings has a focus on the youth segment and in recent years has been successful in growing overall market share. At the same time operating efficiencies continue to be targeted and achieved, helping support margins and deliver earnings growth.
As Macquarie notes, net margins for NIB Holdings have increased from 3.6% in 2007 to 6.1% now as policy holder market share has risen from 6.6% to 7.6% over the same time. Since 2007 NIB Holdings has also returned around $185 million of excess capital through special dividends, a buyback and a capital return. Return on equity has been above 15% since 2010.
Key issues for the private health insurance sector in Macquarie's view are the introduction of income testing for PHI tax rebates and the Private Health Insurance Administration Council (PHIAC) position on pricing and current margin levels.
With respect to the former, a survey by Macquarie suggests private health insurance coverage could reduce by 1.0-1.5% given means testing for the tax rebate. At the same time, comments from the PHIAC suggest price competition in the private health insurance sector is not as sharp as it could be given current capital positions and margin outcomes for the industry.
Macquarie has factored a decline in margins into its model for NIB Holdings, its model suggesting from 6.1% in FY11 net underwriting margin is likely to come in at around 5.9% in FY12. Earnings growth for NIB Holdings should still be achieved even given lower margins.
Earnings per share (EPS) forecasts for Macquarie stand at 12.4c in FY12 and 13c in FY13, which compares to consensus EPS estimates according to the FNArena database of 13c and 14.3c respectively.
Macquarie's earnings estimates translate to a price target for NIB Holdings of $1.70, which is in line with the consensus price target in the FNArena database. Targets range from Citi at $1.60 to BA Merrill Lynch at $1.75. The database shows all four brokers covering the stock rate NIB Holdings as a Buy.
At current levels NIB Holdings is trading at a discount to what Macquarie regards as a fair earnings multiple, which implies upside potential. Earnings rather than any multiple expansion have been the major driver of share price performance for NIB Holdings, as Macquarie notes the stock has traded at an average 11% discount to the small industrials index over the past 18 months.
BA Merrill Lynch agrees there is value in NIB Holdings, pointing out while organic growth is becoming tougher to achieve, the stock offers a 12-month potential total return of around 18%. This is despite solid share price performance in recent years.
Part of this return comes from attractive dividends, as Macquarie's numbers imply a fully franked yield of 8.9% in FY12 and more than 6% in FY13. Special dividends such as the 5c per share paid out in the second half of 2011 are likely to continue in Macquarie's view.
Shares in NIB Holdings have traded in a range over the past year of $1.11 to $1.705, the current share price implying upside of around 10% relative to the consensus price target in the FNArena database.
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