Monday 31st October 2016
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While Medibank Private has been in the press a lot of late for various reasons, it has been the release of the company’s FY16 results and the subsequent changes to the Executive Leadership Team that are of most interest to us. Unfortunately for Medibank Private and its shareholders, neither of these announcements has been able to reverse the downward trend in the company’s share price that has been in place since the record high reached in May 2016.
Starting with the recent executive changes, the key point to note is Medibank Private’s intent to improve its customer service, with this having been reflected through the addition of a Chief Customer Officer to the company’s Executive Leadership Team. This makes sense to us, given both the damage (perceived or otherwise) that Medibank Private’s brand has sustained over the last 12 months or so, and the competitive nature of the PHI industry.
The other key point to note from the announced changes to Medibank Private’s executive team is the announced departure of the company’s Chief Financial Officer. While a search for a replacement has begun, this remains work-in-progress. This is not an ideal scenario, but nonetheless indicative of the new Chief Executive Officer’s intent to ensure Medibank Private has “the right team in place with clear accountabilities” to deliver on the company’s “big agenda”.
While it remains unclear exactly what new management’s “big agenda” entails, it seems reasonable to conclude that it revolves around shoring up Medibank Private’s market position by improving its customer offering and brand image. The good news for Medibank Private’s shareholders is that the recent adverse media coverage does not appear to be having a material impact on the company’s headline earnings, with this due to an exceptional performance on claims and operating costs.
For the 12 months ending 30 June 2016, Medibank Private reported a 53.7 percent increase in its core Health Insurance operating profit on the back of a 4 percent increase in premium revenues and a 74.6 percent increase in its Complimentary Services operating profit despite an 11.2 percent decline in segment revenue. This in our view highlights that Medibank Private is continuing to benefit from both regulated premium increases and the optimisation of its value chain.
However, peeling back the layers, we see one glaring shortcoming with Medibank Private’s FY16 results - that is, the continued erosion of the company’s core policyholder base. This is evident in the fact that Medibank Private’s reported revenue growth for FY16 is below the weighted average regulated increase in premiums, with this due to 3.8 percent decline in higher margin Medibank policyholders, which more than offset a 5.0 percent increase in lower margin ahm policyholders.
The good news in our view is that Medibank Private has a very strong capital and market position from which to navigate what has and is likely to continue to be a difficult period for the company (both from an operating and investment returns perspective). In terms of Medibank Private’s prospects for FY17, we note that while management has not provided any explicit earnings guidance, it does expect the current financial year to be similar to 2H16, which was below 1H16.
Based on consensus estimates for FY17, Medibank Private is trading at 17.1 times and yielding 4.5 percent with an ROE of 24.9 percent. In comparison, NIB Holdings is trading at 19.7 times, with a yield of 3.4 percent. In our view, Medibank Private’s reasonably compelling relative value is supplemented by what we consider to be a robust technical set up, with both the 50-day moving average and the relative strength indicator being indicative of an exhaustion of near-term selling.
We view Medibank Private’s declining policyholder base as being more cyclical than structural. Having arguably been too effective at expanding Medibank’s profit margins through tighter control of claims and operating cost at the expense of its value proposition, we now expect management to seek a more optimal balance between the two earnings levers. Notwithstanding the potential for some near-term earnings weakness, we remain positive on Medibank Private’s long-term thematic.
James Lennon is a senior analyst at investment research and funds management house Fat Prophets. To receive a recent Fat Prophets Report, CLICK HERE
Disclosure: Medibank Private is held within the Fat Prophets Concentrated Australian Share, Income, and Small/Mid-Cap Models.
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