We recently researched Medibank Private (ASX:MPL) in The Dynamic Investor after several important ASX releases. Medibank Private’s core business is the underwriting and distribution of private health insurance policies through its two brands, Medibank and AHM. The AHM brand is positioned around affordability. The Company offers Hospital Cover and Extras Cover to customers in Australia as well as health insurance to overseas visitors and students. The latter offering is via the Health Insurance division, which also provides integrated healthcare services.

Key Fundamental Drivers of Medibank Private

Well Positioned to Further Increase Market Share

Relative to industry growth, MPL has been gaining market share in the resident Private Health Insurance (PHI) segment. Market share is currently around 27.5%, which has risen by +3 basis points since FY22. The Company is targeting 25-75 basis points of market share gains by FY25 (from FY22 levels).

Medibank Private is in the early stages of rolling out its own alternative care model for short-stay, no-gap joint-replacement surgeries. This has the potential to further improve market share. Under this model, hospital stays are between 1-3 days, compared to the current average length of stay for knees/hip replacements at 5.3 days.

The short-stay program has recently been expanded to other highly-utilised modalities, with endoscopy and general surgery underway. Apart from the potential to increase its market share, the model offers upside risk to longer-term EPS. This is because the model alleviates pressure on premiums (via lower claims growth) and eliminated patient co-payments.

In addition, costs per episode are typically 20% lower than standard inpatient model. Importantly, there is scope for further cost savings, given that at present, only ~4% of MPL’s procedures are now carried out via the short stay model.

Over the short term, lower claim costs enable MPL to implement lower premium increases than the rest of the market. In turn, this keeps premium rate increases low relative to wages growth. This would allow the Company to attract more policyholders and potentially increase market share in the short term. It also positions the Company well given that policyholder lapse rates and switching may intensify in light of rising affordability pressures.

Favourable Trends for Non-Residential Segment

Non-residential activity is a smaller, but rapidly-growing, earnings contributor for MPL. It accounts for ~5% of MPL’s total health insurance Gross Profit.

In contrast to the resident policyholder figures, non-resident activity has been much stronger. Policy numbers for the March 2023 quarter rose by 12%, on the back of continued recovery in the number of international student and worker visas being issued.

Based on statistics for the March 2023 quarter, visa applications for international students remain strong. In context, visa applications for international students are a key lead indicator for the non-Residential segment.

For 1H23, non-resident underlying gross profit margin in 1H23 was 34.1%, compared to 21.5% in 1H22, as a result of improved mix and aging of the portfolio. The continued recovery in international students, as well as government policy to increase migration to address skill shortage were the key drivers of growth. Gross profit margin is expected to continue expanding, as these trends continue.

Negative Implications from Increased Capital Requirements Following Cyber Incident

Following the cyber event that impacted MPL in October 2022, APR has imposed additional capital requirements on the Company. This takes effect from 1 July 2023 and will remain in place until MPL completes an agreed cyber remediation program to further strengthen its systems.

While MPL has confirmed that it has sufficient existing capital to meet the additional $250m operational risk capital charge, there are two key potential negative implications. Firstly, the Company may become more conservative with respect to capital management in the near term, especially in relation to special dividend payments.

Secondly, the Company may issue Tier 2 debt, which is allowable under the new capital standards. This will enable MPL to pursue planned growth in the Medibank Health division over the next three years.

Fundamental View

We see MPL shares as having more medium-term appeal. This is because the opportunity for additional market share from the alternative care model still require further investment. In the meantime, the Company faces several short-term challenges. These include:

• Rising lapse rates are now starting to match the growth from new policyholders. This trend may intensify in light of rising affordability pressures and health fund premium increases over the 2nd half of calendar year 2023.
• The additional capital impost reduces the capacity for MPL to invest excess capital in either capital management or bolt-on acquisitions. These factors limit upside risk to the EPS growth profile of ~4.5% over FY23-25 on a CAGR basis.

Charting View

Since last April, it had appeared as though MPL was forming an ascending triangle (indicated by the blue lines). However, instead of breaking to the upside, MPL made a downside break (circled). We would expect the shares to continue drifting lower from here. The next area of support is down near $3.20. That will provide those medium-term investors with a better entry point.

 

Michael Gable is managing director of Fairmont Equities.

 

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