Shares in NIB Holdings (ASX:NHF) enjoyed a stellar run over a 12-month period to August this year, as earnings became a net beneficiary of COVID-19. Policyholder growth for the core Australian business in FY21 outstripped the industry average; margins expanded as a result of lower claims savings; and premium rate increases were above the industry average.
That stellar run came to an end following the release of full year results for the 12 months to 30 June 2021 (FY21). The result showed worse-than-expected losses in the Travel and International businesses.
With this in mind, we recently researched the Company to assess whether the market may be underestimating the group earnings growth potential, especially given that COVID-19-related impacts on business are starting to subside.
About NIB Holdings
NIB Holdings is a provider of private health insurance in Australia and NZ and is also a provider of travel insurance and health insurance for inbound international students. The main earnings driver for NHF is the domestic business, Australian Residents Health Insurance (ARHI). The Company’s main competitor in the Australian Private Health Insurance (PHI) industry is ASX-listed company Medibank Private (ASX: MPL).
Key Fundamental Drivers
Upside Margin Potential for Australian Business
The reported net margin in FY21 of 9.7% included one-off benefits, namely claims savings as a result of COVID-19. Excluding these one-off benefits, the reported net margin is estimated to be closer to ~5.5-6.0%.
While the reported net margin is expected to moderate to ~6% over time (i.e. as claims savings dissipate and as claims are normalising, particularly with elective surgery recommencing), net margin may increase in FY22 as a result of:
i. Strong premium rate increases. In December 2020, the federal government approved private health insurance premium increases, to take effect from 1 April 2021. NHF’s premiums rose by an average of 4.36% versus 3.55% average over the past three years. Therefore, the premium rate increase for FY22 assumes 4.36% for the first nine months of FY22 and at least +2.9% for the remaining three months of FY22 (reflecting the rate of claims inflation).
ii. Ongoing operating efficiencies through claims automation and digitisation.
A key variable for the reported net margin in FY22 is the extent to which the Company generate further claim savings from the more recent lockdowns. While the more recent lockdowns should see further claims savings for NHF, how much of these savings that are ultimately returned to policyholders remains unclear.
Low Earnings Visibility for Inbound International Health Insurance
The IIHI business reported a 2H21 underlying loss of -$6m compared to a ~+$1m profit in 1H21. The result was impacted by lower revenue (on higher book amortisation linked to COVID-19) and increased claims on higher use of services by students and business mix impacts. These pressures appear likely to continue in FY22.
The Company had reiterated in May 2021 that the business was profitable. However, while IIHI appeared to be profitable in early May, several high-cost claims and lower premiums led to a $5.9m loss in 4Q21. This experience suggests that earnings visibility in the IIHI business remains low.
Further, the Company appears to be unclear about the short-term impacts from higher claims and lower premiums, with profitability only expected to return once international travel resumes.
nib Travel Well Positioned for Recovery
NHF reported a soft result for the Travel business in FY21, which was expected, given the same challenges regarding COVID-19 lockdowns and associated travel restrictions were evident in FY20. An underlying operating loss of $13.6m for FY21 (with losses appearing to have stabilised over 2H21) compared with a $19.7m operating loss in FY20.
The improvement was driven largely by cost savings and a re-adjustment of the cost base of the travel business. In addition, the Company has updated the majority of its travel insurance products to include additional COVID-19 cover. These measures have positioned the business to benefit from borders re-opening and the recommencement of travel. Indeed, demand for travel insurance has been promising in markets where travel restrictions have been eased or are easing.
Balance Sheet Metrics Have Improved
NHF’s balance sheet remains robust, with an improvement in all key balance sheet metrics seen over FY21. Namely, gearing (on a total debt to (debt + equity) basis) over the course of FY21 progressively declined by ~310 basis points to 25.2% and remains below NHF’s long-term average gearing target of 30%.
The improvement in gearing was achieved despite Operating cash inflow in FY21 being impacted by lower premium received in advance for the IIHI business as well as lower travel insurance income.
In addition, available capital is above internal targets and has increased by 22% to $65.7m, supported by COVID-19 uncertainty and a reduction in capital required for non-regulated entities.
While an eventual recovery in the profitability for both the IIHI and Travel businesses is likely upon the resumption of international travel, the main value driver for NHF remains the ARHI business. To this end, earnings visibility is poor. In particular, COVID-19 continues to impact all of NHF’s businesses and within the ARHI business, the recent lockdowns add another layer of uncertainty in regard to the extent to which further benefits will be passed onto policyholders.
Accordingly, we take a cautious view, as the shares trading on a 1-year forward P/E multiple of ~21x, which is broadly in line with the historical average, and the EPS growth profile of 1% from FY21-24 on a CAGR basis is unappealing.
In August, we saw NHF get close to its 2019 high, but it was then sold down sharply. It is struggling to make much headway here so there is still risk that it eases back further. It now also appears to be breaking under the uptrend line. We would be targeting support closer to $6 before reassessing.
Michael Gable is managing director of Fairmont Equities.
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