A little over two months ago, investors couldn't get enough of it, but now there are some ominous signs for the ex-government owned Medibank Private Ltd (ASX: MPL).
In the months following its highly anticipated public float, early retail investors were treated to a paper profit of nearly 30% as the stock rocketed to a high of $2.59. That was late February, and the shares have since declined more than 16% and are today trading 2% lower at $2.165 – a new 2015 low. In fact, they're only sitting 4% away from hitting their lowest price, ever, at $2.08.
As promising as investors found the business in the lead up to its initial public offering (IPO), it was always clear that the government was getting a great deal.
They reaped $5.7 billion from the sale of the business – well in excess of the amount it initially expected – with investors expecting similar returns from Medibank as they had grown accustomed to from prior government sales, including those of CSL Limited (ASX: CSL) and Commonwealth Bank of Australia (ASX: CBA).
To me, it certainly appears as though the government got the better end of the deal this time around.
Here's why you should avoid Medibank Private
Medibank is a high-quality business in many respects. Indeed, you can't become the nation's biggest health insurer without having certain strengths and attributes.
But what many investors failed to realise prior to buying the shares is that much of Medibank's future growth will come from its ability to reduce management costs, and improve efficiencies. Given the premium at which the shares are currently trading (even after their recent decline), it appears investors expect those improvements to be made almost overnight.
Making it more difficult for the company to grow earnings is the cannibalisation of its Medibank-branded policies from its discount brand, ahm. While the ahm brand, which attracts lower margins, recorded growth of 19.6% during the most recent half-year period, the Medibank brand actually contracted by 1.5%, which isn't such a good indicator for the long term.
Furthermore, Medibank Private is not the stock for you if you're looking for dividends in this low interest rate environment. In its prospectus, the company said it would pay an interim dividend of 4.9 cents per share for the seven months to 30 June 2015, putting it on a current yield of just 2.3%. That's considerably less than what other insurers such as QBE Insurance Group Ltd (ASX: QBE) or Insurance Australia Group Ltd (ASX: IAG) are offering.
Indeed, there could come a time where Medibank Private deserves a position in your long-term portfolio but at its current price, I expect it could simply act as a drag on your overall returns.
