Medibank Private (ASX:MPL) shares have come off is recent highs after reporting its full year result. While some aspects of the result (i.e. policyholder growth) disappointed the market, we identified some green shoots. With this in mind, we recently researched the Company in The Dynamic Investor to assess the prospects of a recovery in the share price.

About Medibank Private

Medibank Private’s core business is the underwriting and distribution of private health insurance (PHI) policies through its two brands – Medibank (which accounts for ~75% of polices) and AHM. The AHM brand is positioned around affordability. Its contribution to total policies has increased from ~15% in 2016 to ~25% currently.

The Company offers Hospital Cover and Extras Cover to customers in Australia as well as health insurance to overseas visitors and students (via the Health Insurance division). Via the Medibank Health division, it also participates in the broader healthcare industry through the provision of integrated healthcare services.

Key Fundamental Drivers

Is There Scope for Market Share Growth?

A disappointing aspect of the FY24 result was that resident policyholder growth of +0.7% came in well below guidance of +1.2% to +1.5% for FY24. The key reasons for the lower-than-expected policyholder growth were that sustained competitive pressures resulted in higher lapse rates and higher customer acquisitions costs. In addition, policy downgrading remains elevated and is expected to remain so in FY25.

The increase in competitor activity in 4Q24 and mitigated the typically strong policyholder growth in the 4th quarter of the financial year. In addition, the Company largely refrained from engaging in its competitors’ activities. MPL views that customers acquired under this strategy generally have lower revenue per policy and much higher lapse rates. As a result of this strategy, PHI grew slightly below market.

MPL aims to grow in line with market during FY25 and gain share from FY26. However, we expect any market share gain will be minimal. This is reflected in the Company’s policyholder market share target being revised to a +25-75 basis points increase by FY27 on the FY24 market share of 26.75% at March 2024. The previous target was a +25-75 basis points increase on the FY23 market share of 27.08% by FY26. In addition, continued competitive pressures, coupled with MPL management strategy to not engage in discounting, implies that there is a risk of MPL’s policyholder growth in FY25 being slightly below market.

Margin Performance Expected to Improve

PHI margin rose by 0.2% to 8.8% in FY24. This was largely explained by Resident claims inflation of 2.2% compared with average premium increase of 2.6%. A similar trend is expected in FY25 given that the average premium increase of 3.3% (already implemented) exceeds Company guidance of 2.7%.

The expectation for higher net margin also comes despite higher expense growth and a rise in ongoing cyber-related expenses over FY25-26.

MPL believes it has reached the peak of cost inflation in FY24 which saw the overall Management Expense Ratio (MER) increase by 30 basis points to 7.8%. However, this was predominantly driven by an increase in sales commissions (+20 basis points). This reflects the increased portion of AHM sales via the aggregator and growth in non-resident sales commissions.

While the MER could increase further, two factors can partly offset this. Firstly, further productivity savings and secondly, a modest increase in sales commissions.

Strong Capital Position

MPL has a strong surplus capital position. As such, MPL is well placed to fund further growth and support Merger & Acquisitions (M&A) aspirations and can raise Tier 2 debt should further attractive investment opportunities become available. MPL has an M&A target of $150m-$250m between FY24 and FY26 in order to bring its Medibank Health business to scale. In the absence of suitable M&A opportunities, capital management will be considered.

Fundamental View

The recent weakness in MPL now sees the shares trading on a 1-year forward P/E multiple of ~17x, which is at a significant discount to the historical average multiple of ~19.5x. The current multiple is also at the lower end of the range over the last ~2 years.

The EPS growth profile over the medium term is moderate (~3% over FY24-27 on a CAGR basis). This is a function of robust growth in the non-resident division and Medibank Health being somewhat counterbalanced by another year of high “non-recurring” expenses. However, we consider that there is upside risk to the EPS growth profile from:

• Potential acquisitions and/or capital management
• Management’s ability to generate operating leverage despite lower policyholder growth and claims inflation in the resident PHI business.

Charting View

MPL appears to have been trading in a range since late 2022. At the moment it is at the lower end of that range and it appears to be finding support here. MPL is therefore likely to head higher from this level and retest the old high near $4.

 

Michael Gable is managing director of Fairmont Equities.

 

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