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Medibank Private Ltd shares face regulatory headwinds in 2016

Shares in private health insurance giant Medibank Private Ltd (ASX: MPL) traded flat today as the business passes two years as a public entity to sell for $2.10 a smidgen above the $2 retail offer price at the IPO stage back in 2014.

The stock has traded as high as $2.59 as investors got excited about the company’s ability to potentially lift margins via cost cutting as it transitions from a government business enterprise to ASX top 100 company.

Medibank has succeeded in cutting its management expense ratio as a private enterprise and posted a pro forma net profit of $292 million in FY15, up 12.9% over the prior year.

However, the business faces challenges in the year ahead with the Fairfax press today reporting a spokesman for the government’s Health Minister Sussan Ley as saying on private health insurance: “The Minister maintains her concern about the growing number of junk policies and hidden catches…The government is focused on getting the balance right between ensuring strong competition and high-quality, straight-talking health cover.”

The potential for regulatory reform in the sector is likely to make Medibank investors nervous, while the group also faces a battle in persuading Australians already feeling the pinch thanks to flat wages growth to maintain their private health cover, when there is a largely free healthcare system as an alternative.

However, the public Medicare system also looks set for government cutbacks, while Medibank itself is also putting pressure on hospitals to more effectively manage costs that are sent to the insurer as billings.

Given the potential headwinds the group’s valuation on around 18x analysts’ estimates for earnings is probably about fair value, as this is a reasonable quality business with plenty of levers to pull in the quest to lift profit.

Another private health insurance business for investors to consider is NIB Holdings Limited (ASX: NHF). It faces similar opportunities and challenges to Medibank, with both businesses reasonable prospects at the right price for conservative investors.

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Motley Fool contributor Tom Richardson has no position in any stocks mentioned.

You can find Tom on Twitter @tommyr345

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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