Health insurer Medibank Private Ltd (ASX: MPL) released its full-year 2016 results to the market this morning. Apart from delivering the bumper profit that was forecast several months ago, there were a few warning signs that should encourage would-be buyers to stay on the sideline.
Here's what you need to know:
- Health insurance premium revenues rose 4% to $6,173 million
- Complementary service revenues dropped 11% to $569 million primarily due to divestments
- Net Profit After Tax rose 46% to $417 million (includes $23m in one-off tax benefits)
- Earnings per share rose 46% to 15 cents per share
- Dividends of 11 cents per share (3.7% yield)
- Gross margins widened from 14.2% to 16.6%
- Operating margins widened from 5.6% to 8.3%
- Management expense ratio fell from 8.6% to 8.4%
- Number of members decreased by 2.6%
So What?
In this article earlier in the week I highlighted three key issues that Medibank shareholders should watch for. The first was the success of cost-cutting and claim control initiatives, and they speak for themselves with profits up 46% despite only a 4% increase in revenue. The management expense ratio also dropped, and costs would have been lower if not for a one-off expense of $14 million relating to an IT upgrade.
The second issue was competition and customer numbers, and here Medibank did not fare so well. Despite a legislated premium increase of 6.59%, Medibank's premiums only rose 5.1% due to customers downgrading their level of coverage. Additionally, Medibank's total customer numbers declined 2.6%, suggesting the group lost market share or more people dropped their health insurance entirely (or both). The worst part is that policyholder numbers were only down 0.6% in the six months to December 2015, so the decline has accelerated in the second half of the year.
Third, I suggested readers watch for comments from new CEO Craig Drummond (these can be found in the media release). I paraphrase, but Mr Drummond said "…some challenges remain with the value we offer to our customers. What is clear is that we need to put our customers at the centre of everything we do….As a result, in 2017 Net Promoter Score will be introduced… (as part of) management incentives." (emphasis added).
Now What?
Those comments from Mr Drummond underline the accelerating loss of customer numbers, and Medibank has outlined a strategy to improve its situation. The company will improve the value it offers to customers, utilise an improved policy management system, reduce call waiting times, make claiming easier, and strengthen customer engagement through digital initiatives. Over the longer term Medibank would like to transition from 'health insurer' to 'health assurer', which I interpret to mean it will link claims payments to health outcomes for customers. Some of this has been in effect already with Medibank introducing more stringent guidelines for hospitals to which policyholders might be sent.
Medibank's comments about 'addressing' the rising cost of healthcare remind me of the Sonic Healthcare Limited (ASX: SHL) report on Wednesday in which that company talked about cutting costs. Every business in the medical industry is looking at passing on costs to others, but ultimately it's only those with the greatest amount of market power – like Medibank – that can pull it off. I suspect additional revenue pressure will materialise further down the chain in hospitals, diagnostic clinics, and medical supply companies.
Still not a buy
Medibank has a good financial position. As Peter Lynch once quipped, it's extraordinarily difficult to go broke when you don't have any debt, and Medibank is delivering positive free cash flows to boot. However with customer numbers in decline, acknowledged underperformance in its key business, and rampant competition from the likes of privately-owned Bupa, Medibank does not look like a buy right now.
The company trades at approximately 20 times earnings – around the ASX average – but this is expensive. Medibank didn't offer any financial guidance, and the outlook is to expect continued market share loss, slowing market growth, and increased investment in marketing customer satisfaction. I expect profits will take a hit in 2017 as a result of these issues.
Lest I sound too bearish, let me say that Medibank is a solid company (facing some challenges) but neither its existence or its dividend appear under immediate threat, while its core business has attractive long term characteristics. It's just not a 'Buy' today – only a 'Hold'.
