Readers may have seen an article in Fairfax media this morning titled 'Why investors hate Medibank', describing Australia's largest listed health insurer as 'one of the most hated large-cap stocks on the ASX'.
Are things really that bad at Medibank Private Ltd (ASX: MPL)? What's all the fuss about? Didn't the company just upgrade its full-year profit from $370m to above $470m?
There are several aspects of Medibank that attract scrutiny. One is its apparently elevated price; a trailing Price to Earnings (P/E) ratio of 24 is not cheap. However, on a forward P/E basis (i.e., for the current financial year), Medibank's ratio appears to be around 18 based on my ballpark calculations, which assume the same investment earnings as last year and a corporate tax rate of 28%.
Thanks to the recent profit upgrade, Medibank appears marginally cheaper than QBE Insurance Group Ltd (ASX: QBE) on a P/E basis, and equivalently priced to Insurance Australia Group Ltd (ASX: IAG), another general insurer. Medibank's closest analogue on the stock market, NIB Holdings Limited (ASX: NHF), also appears to trade on a P/E of around 18 times for the current financial year, depending on tax rate, corporate overheads, and investment earnings.
While my figures here are 'ballpark' only, they indicate that Medibank is (roughly) equivalently priced to its peers, at least on a P/E basis.
However, this leads to the next common complaint, which is that Medibank is growing revenue more slowly than peers, and the legislated premium increases implemented by the government. To put it another way, the government permitted health insurers to increase their prices by 6.5%, yet Medibank's revenues only grew 4.6%.
Managing Director George Savvides (quoted in Fairfax) attributes this to loss of market share and electing to focus on quality products (and not due to competing on price, or customers reducing cover levels) and believes the company has been under-investing in its brand, which he aims to rectify in the second half of this year.
A third common criticism is that after the recent upgrade, Medibank has run out of room to reduce its claim costs and operating expenses. Given that the company has identified up to $3 billion in savings to be made in our healthcare system, I believe these assertions could be inaccurate. Mr Savvides is bullish on the potential for improvement in this area, and recent deals like the arrangement with private hospital operator Healthscope Ltd (ASX: HSO) show that Medibank has the muscle to demand more favourable terms from providers.
So while Medibank is heavily criticised in the media, it is not as poor a business as might be expected at first blush. Recent performance appears to have justified its trailing P/E ratio, management has a plan to tackle slow revenue growth, and there appears to be room to make further meaningful reductions in claim expenses.
I would mark Medibank as a 'Hold' today, and believe existing shareholders should think twice before selling their shares in response to bearish headlines.
