Shares in Medibank Private Ltd (ASX: MPL) have fallen sharply since the release of its half-year results in February. The market had been very enthusiastic towards the Medibank Private float following some great marketing from the government and positive recommendations from several brokers. The shares climbed steadily towards $2.59, but they are now trading just above the IPO price at $2.07.
Medibank Private may be the largest private health insurer in Australia, but this alone is not enough to see the company outperform the market in the short to medium term. Here are some reasons I think Medibank Private is a company investors should be avoiding right now:
1. Affordability. As a result of increasing healthcare costs, claims inflation has been increasing which means premiums need to rise in order for margins to be maintained. As the price of premiums rise, policies become less affordable for consumers. Competition is increasing in the sector and it is now easier for policyholders to switch to more affordable cover. Medibank Private may need to sacrifice margins in order to keep and attract new policyholders.
2. Valuation. Even at the current share price of $2.07, Medibank Private shares are still not cheap. They are trading on a forecast price to earnings ratio of more than 22 and that is a large premium to the rest of the market. The private health insurance market is only growing at a moderate pace and Medibank's policyholder numbers are growing below the annual growth rate of between 2% to 3%. This means the short-term growth prospects for Medibank Private are not looking so positive and it becomes difficult to justify such a high valuation.
3. Cost Cutting. Investors were expecting management to improve the efficiency of the previously government-owned business. Once the half year results were released in February, it became clear to the market that it would be more difficult to reduce the cost base. While management is still working on reducing expenses and increasing operational efficiencies, the market can be impatient. Until the changes are implemented, earnings growth may be limited as Medibank Private may not be able to increase premium revenues faster than claim costs.
There are several other reasons I would avoid buying Medibank Private shares, but I have listed the three that I believe will be the most important to investors thinking about buying shares in the company. The long-term fundamentals for the private health insurance industry are still positive, but I think short term headwinds will impact earnings growth in the near term.
I will be keeping Medibank Private on my watchlist, but I believe there are better opportunities available at the moment.
