No Quick Fixes For Medibank Private

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This story features MEDIBANK PRIVATE LIMITED.
For more info SHARE ANALYSIS: MPL
The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

The prospects for Medibank Private in the medium term rest on whether it can stabilise market share and retain healthy margins.

-No quick fixes for customer lapse rates
-Claims outlook is a key swing factor
-Regulation potential may signify downside
 

By Eva Brocklehurst

The prospects for Medibank Private ((MPL)) in the medium term rest on whether the company can stabilise market share and retain healthy margins. FY17 results were weak but the health insurer surprised to the upside, with gross margins that actually rose versus FY16 from levels which many in the market believed were already unsustainable.

Margins were supported by continued benign outcomes on claims, albeit up from very low utilisation rates in FY16. Nevertheless, volume trends revealed increasing lapse rates and industry-wide reductions in participation.

The absence of system growth remains a key concern for the industry and one which Bell Potter highlights. Medibank has made improvements in customer service levels, which have contributed to better earnings, but operating profit in health insurance was modestly lower than in the previous year. Bell Potter, not one of the eight stockbrokers monitored daily on the FNArena database, maintains a Hold rating on the stock with a target of $2.81.

Lapse Rates

Ord Minnett observes the Medibank brand is losing customers at a very sharp rate and does not envisage any quick fixes. Price reductions are not expected to address the volume issue, and health insurance is a complicated product where it is difficult to compare on price.

At the current price/earnings ratio, around 18x, the broker believes the stock is undemanding, as long as growth eventually returns to policy numbers. Nevertheless, that prospect appear to be some time away.

UBS believes the implications for revenue momentum over the next few years are not significant, and assumes market share losses are pared back by FY19. The broker found the outlook mixed but concedes there was a better prospect for management expenses, albeit not enough to offset margin pressures. The claims outlook remains the key swing factor and here the company is vague, suggesting only that hospital utilisation growth is likely to run at 3.6%.

Citi is inclined to view the business as performing better than the bearish market commentary suggests, although still expect a decline in earnings per share in FY18 as investment earnings normalise. Health insurance management expenses were also higher in FY17 although to look set to fall materially in FY18. With policy downgrading still a major feature of the health insurance market and lower premium rate increases this year, Citi suspects there will be downward pressure on gross margins.

Morgans was pleased with the results, given the outlook commentary was more positive regarding health insurance gross profit margins and management expenses. The broker also notes some signs the leakage of policy holders is stabilising.

As the gap has narrowed to the broker's valuation the rating is upgraded to Hold from Reduce. Still, the -4% decline in Medibank policy holder numbers remains disappointing. The broker envisages upside risks primarily from management being able to deliver more cost reductions and starting to reverse the market share losses.

Emerging Risk

One emerging risk is the chance of an early election if the High Court rules against the eligibility of certain parliamentarians, who provide the government with a majority. A change of government may be seen as potentially harmful to private health insurers. As a result, Ord Minnett believes it prudent to retain a Hold rating.

Credit Suisse also highlights this risk, assuming the positive stock price reaction was driven by the CEO's comment that the government would probably announce industry-supportive reforms before the end of 2017. In the broker's view, for a company that is concerned about customer affordability and continues to deliver inflated profit margins, the regulation potential is to the downside.

The broker points out the government does not have to look much further than recent industry statistics and Medibank's latest result to see that the consumer is the big loser in this favourably-regulated industry. Hence, the share price reaction to an in-line result was a surprise. That said, Credit Suisse believes management is doing a good job on costs and demonstrating a gradual improvement in market share.

Macquarie is much more positive and considers the business is getting healthier. The structural headwinds facing the sector are well understood and regulatory change is required, which may involve less intervention to support an efficient public-private health system.

Morgan Stanley is not convinced. Given affordability issues, any assumed margin expansion and premium rate increase leading into an election year could prove optimistic. The broker believes the stock is arguably over-earning, while guidance assumes hospital utilisation growth rates are unchanged.

There is one Buy rating (Macquarie) on FNArena's database, three Hold and three Sell. The consensus target is$2.82, suggesting -4.7% in downside to the last share price. The dividend yield on FY18 and FY19 forecasts is 4.1% and 4.2% respectively.
 

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