Last week was an eventful week for Medibank Private Ltd (ASX: MPL) shareholders after it was revealed that the Australian Competition and Consumer Commission (ACCC) would take legal action against the private health insurer for misleading consumers.
The shares plunged more than 8% on the day of the announcement, but managed to claw back some of those losses throughout the rest of the week as investors took some time to absorb the news.
Despite last week's setback, those shareholders who have held onto their shares since Medibank floated in December 2014 would be pretty happy. The shares have managed to increase by nearly 36% since listing, and as the chart below highlights, they have outperformed the broader market significantly.
The shares have performed well over the past 12 months in particular, and surprisingly, Medibank has been the second best performing large-cap stock during that period. Only gold miner, Newcrest Mining Limited (ASX: NCM), has put in a better performance.
Is Medibank a buy at $2.95 per share?
There are a number of reasons you could be bullish or bearish on Medibank right now.
Some of the reasons I would avoid Medibank include:
Sluggish Revenue Growth – Although Medibank recorded a strong rise in first half profits, the majority of the gains were made through cost savings. Revenue increased by only 4.6% with the company blaming slowing growth across the industry and higher churn rates. This sluggish revenue growth may become a serious problem in the future as there will come a time when cost saving measures no longer have an impact.
Higher customer premiums – The cost of healthcare is expected to significantly outpace the rate of inflation over the long term based purely on the dynamics of supply and demand. Inevitably, private health insurers will have to pass on these costs and this will put more pressure on premiums which could deter some people from having private health insurance. Worryingly, Medibank reported a 1.2% decline in policyholder growth in the first half and a significant increase in its customer lapse rate.
Valuation – Medibank shares are currently trading on a price-to-earnings ratio of around 21. This is not particularly cheap unless you are confident the company will continue to strip out costs in a bid to drive earnings growth.
Some of the reasons I would buy Medibank include:
Potential for further short-term cost savings – Medibank's first half results showed the company made solid progress in reducing costs by clamping down on fraudulent claims and by negotiating better pricing with hospitals. The company is expected to improve operating margins by squeezing out further cost savings and this should help to support earnings in the short term.
Solid dividend – Investors can be pretty confident that Medibank will pay a solid dividend for the foreseeable future. At the current share price, investors can expect a fully franked dividend yield of around 3.6%.
Debt free balance sheet – Medibank has no long term debt on its balance sheet which means the company is in a fairly healthy financial position.
Foolish takeaway
Based on the points above, I would be inclined to avoid Medibank shares for the time being as the company is losing policyholders and cost savings can only go so far in the short term.
If the shares become cheaper or top line growth begins to accelerate, I would be far more confident in becoming a shareholder of the company.
