Credit Suisse Slapped An 'Underperform' Rating On Medibank Private: Here's Why

Photo: Getty/Scott Barbour

The Medibank Private float was one of the biggest and most successful in Australian capital raising history.

Individual investors, who were allocated shares at $2 each, saw the price open at $2.22 and close at $2.14, a 7% premium. Institution investors, who paid $2.15 a share, weren’t so blessed.

The buying and selling was a frenzy in the first 30 minutes of trading and by the end of the day $1.2 billion in shares were traded.

And the seller, the federal government, banked $5.679 billion from the float.

The business prospects for Medibank Private this year and next look good but the longer term may not be as upbeat as first thought.

Credit Suisse has just placed an “underperform” on the stock.

The current share price implies sustained double-digit earnings growth, which Credit Suisse sees as unlikely.

Earnings growth is expected to be good between now and 2017 but will slow after that.

The shares currently look expensive when compared to the rest of the market. They are trading on 20.5 times 12-month forward earnings, a 38% price/earnings premium to the ASX and above the major banks which trade at 12.6 times earnings.

In the short term, Credit Suisse expects Medibank Private to beat the current prospectus forecasts by roughly 4% due to a higher gross margin and better investment income.

Medibank Private’s place in the health insurance industry is a good one. It is the largest provider with a 29.2% market share of policies.

Policyholder growth has been strong over the past decade but this has been slowing in recent years, with 2014 financial year growth of 2.6% the lowest annual rate since 2006.

And Credit Suisse expects growth to slow from the current 3% to 4% a year to around 1% to 3%.

Competition has increased, driven by industry consolidation, an increase in the number of for-profit funds and the rise of online aggregators.

In June 2003, six of the 44 health insurance funds were for-profit but by 2014 that number increased to 10 with the number of funds has reduced to 34.

The entrance of aggregators, such as iSelect, has led to higher industry churn rates. Health insurers are holding on to customers for shorter times before they get lured away by cheaper premium deals. .

Medibank Private is forecasting net margin improvement in the health insurance the current financial year to 5.1% from 4.4% in 2014.

This is to be driven by a reduction in management expenses combined with health insurance premium revenue growth.

“While we expect margin improvement to be delivered by MPL (Medibank Private) in coming years, we caution the expectation of a significant turnaround in the margin and we also highlight that margin improvement will likely be accompanied by lower premium rate increases and hence reduced revenue growth,” Credit Suisse says in a note to clients.

Medibank Private is forecasting a net profit of $258.2 million for the 2015 financial year on total revenue of $6.6 billion.

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