By Paul Rickard

If you are one of the 289,000 Medibank shareholders, the vast majority of whom paid $2.00 for their shares in the IPO in December 2014, then the current price of $3.17 must be looking pretty attractive as an exit point. A capital return of almost 60% over an 18 month holding period is not to be sneezed at.

And maybe it is time to think about an exit, because it is hard to see how things can get that much better for Medibank.

Consider these events over the last few months:

  • Medibank upgrades profit guidance, and delivers a result for the first half that has a health insurance operating profit of $271.7m, up 58.8% on 1H15. The gross margin of 17.2%, mainly from better claims management, compares to a prospectus time forecast for FY15 of 13.6%;
  • Remarkably, the Health Minister approves an effective average premium increase for Medibank of 5.64% for the year commencing 1 April;
  • Medibank announces the appointment on the highly regarded Craig Drummond as its next CEO. Craig commences on 4 July; 
  • Competitor nib announces a profit upgrade on 21 April, pointing to lower claims experience in the third quarter partly on the back of lower hospital utilisation rates; and
  • Medibank reaffirms guidance for a full-year health insurance operating profit above $470m, premium revenue growth of 4.5% to 5.0%, and a management expense ratio of 8.5%.

So, it is little wonder that Medibank’s share price has roared ahead since mid-January, as the following chart shows.

Medibank - June 15 to June 16

Headwinds

Notwithstanding that Medibank will probably deliver well above its current forecast of an operating health insurance profit of $470m (the second half is traditionally lower than the first half), headwinds loom.

Despite the hype about the favourable demographics for healthcare, health insurance affordability is a major issue and the number of policyholders is starting to flat line. Moreover, Medicare is not growing and continues to lose market share - from 30.1% in June 2012 to 28.0% in December 2015.

Medibank Market Share

Source: Medibank HY report and PDS; APRA 2016 Private Health Insurance & Membership

Regulatory reform could also be a headwind for Medibank. It is one of a number of issues facing the private health insurance (PHI) industry, including a formal review commissioned by the Health Minister last October into the value of private health insurance for consumers and its long term sustainability. One of Medibank’s key competitors, nib, recently illustrated the issues facing the industry as per the slide below.

That’s not to say that regulatory reform will necessarily be bad for the industry. One proposal, to introduce reference pricing for prostheses, could save the industry up to an estimated $800m. However, given the exponential and unsustainable rate of growth in health insurance premiums (going up each year by more than 6%), it is hard not to believe that Government initiatives will be targeted at making health insurance more affordable and if not bringing premiums down, slowing the growth rate.

The Brokers

The brokers are neutral on Medibank, however all agree that it is trading well above its target price. According to FNArena, the consensus target price is $2.70 - a substantial 14.8% discount to yesterday’s closing price of $3.17.

On a multiple basis, it is trading on 22.0 times FY16 earnings, and 21.7 times FY17 earnings. The forecast dividend of 10.5c in FY16 and 11c in FY17 sees it trading on a fairly ordinary dividend yield of 3.4% for FY16 and 3.5% for FY17.

Individual broker recommendations

Bottom Line

A multiple of 22 times looks pricey. Medibank is not a growth story. Customers and products aren’t growing, and if not for the premium increase, nor would top line sales. Rather, it remains a cost out story. To the management’s credit, it has more than met its prospectus forecasts and its operating margin of 8.8% in the first-half puts it right near the top of the industry league table. However, it remains to be seen whether there is any opportunity to take this higher.

Take profits.