Medibank's interim result raises questions

Claims continue to trouble Medibank Private and management's cost-cutting story leaves us wondering ... why now?

In the lead up to its November float, Medibank Private (ASX: MPL) was pitched as a cost-cutting story – management would use the company’s scale and negotiating power to push down the cost of healthcare, reducing claims, while at the same time strip out operating costs.

While Medibank’s profit margin increased slightly in its latest interim result, the underlying gross margin fell from 13.6% to 13.4%, which means the company is losing ground when it comes to managing claims.

Lowering the actual cost of healthcare is easier said than done.

Doctors are paid for each service, so they deliver as many as possible, while healthcare providers are out to increase their own revenue by negotiating higher prices. Just two companies, Ramsay Health Care (ASX: RHC) and Healthscope (ASX: HSO), control nearly half of the private hospital industry. Medibank is Australia’s largest health insurer so Ramsay and Healthscope can’t walk away from the negotiating table; but neither can Medibank.

What’s more, Medibank needs approval from the Minister of Health before it can raise its premiums each year. Ironically, if Medibank achieves its cost-cutting goals and increases its profitability, the Government may be even more tempted to let claims growth outstrip premium rises – squeezing Medibank’s margins – to ensure health insurance remains affordable for older voters. And as the Government no longer has an equity stake in Medibank, it has little to lose.

While we don’t expect much improvement in claims, the company is successfully cutting fat on the administrative side of the business – admin costs as a proportion of premiums received fell from 9.2% to 8.0% in the half. Such a quick improvement is impressive.

But it does raise a question.

Current management has been in place for more than a decade. If it was so easy to strip out costs, why not do so while Medibank was still owned by the taxpayer?

Medibank was run as a separate 'for-profit' Government Business Enterprise since 2009 with dividends paid to the Federal Government – can we really blame Government inflexibility? Or was it just a case of lazy management?

The bottom line is that while Medibank is a high quality company, it’s still underperforming its peers, such as NIB (ASX: NHF). Policy downgrades, loss of market share and declining gross margins make it hard to imagine long-term earnings growth above 5% a year. And with the stock now trading on a forward price-to-earnings ratio of 26, there’s better value elsewhere.


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