Medibank stock not in the pink of health as risks become reality

The issue for the Medibank Private stock is that offers no real immediate attractions for growth or yield investors.

As a would-be icon for the next generation of privatisations, Medibank Private is unfortunately tottering very close to failure … and there is little to suggest things will get better.

After kicking off with an IPO price of $2 for retail investors and $2.15 for institutional investors, at yesterday’s price of $2.03 big investors have lost money and returns for mum and dad investors are hanging by a thread.

The picture is actually worse than these raw numbers suggest. If you look at the graph, Medibank Private actually hit a high of $2.56 post float, but it’s been sliding since.

In fact, the health insurer has failed to match the All Ordinaries Index in its first 10 months as a listed company. What’s more, “regulatory risk”, or the risk this stock would be at the mercy of politics has clearly become a ­reality.

Earlier this week Medibank got a bucket load of bad publicity when none other than head of the Australian Medical Association, Brian Owler, publicly castigated the company for the very thing the brokers thought would be profitable …. driving a harder bargain with the hospitals.

Choosing a big stage — the National Press Club in Canberra — to fire his rockets, Owler suggested: “They (Medibank Private) have no understanding of medicine or the people in it.”

From an investment point of view, there is little intrinsically wrong with Medibank Private. The company is clearly a well-run group with strong market share and genuine potential to improve its operations in the future. Rather the problem is with the Medibank Private, the stock.

Few now recall that the indicative price range for the IPO less than a year ago was $1.55 to $2. Unfortunately, in the final weeks of the float process Medibank Private’s “iconic” status lifted demand across all fronts, with the end result the stock came to the market at a very expensive 21 times earnings — the average in the market is about fifteen times earnings.

With all the coverage about the ageing of Australia and our undisputed need for healthcare, Medibank Private got “priced” as if it was a healthcare company, but it’s not … it’s a health insurer.

If you are looking for price growth it is going to be very hard to get it in a highly regulated medical insurance bureaucracy restricted to a country which is moving along at lower-than-trend pace.

If you are looking for income from Medibank dividends, the company is only looking at a normalised dividend yield of 3.5 per cent — that’s low. If you were to choose general insurer as an alternative you could expect 6 per cent at least.

So the issue for Medibank Private — the stock — is that it rests between a rock and a hard place, it offers no real immediate attractions for growth or yield investors. Indeed the key area in which this company is going to get better numbers is in cutting costs — specifically how much it has to hand out to the hospitals at the end of every year.

However, as one of the “bears” on Medibank Private — Richard Coles at stockbroker CIMB — pointed out when he opened coverage of the company with a big fat sell note a few months ago, the stock is overrated.

Coles also tellingly pointed to the difficulty a newly privatised insurer was going to have with not-for-profit clients in any future contract negotiations.

In the recent fight between Medibank Private and the Cavalry health group, Cavalry is clearly appalled at the company’s attempt to rewrite the rule book when it comes to what it will “pay out”. Medibank has issued its hospital contractors a list of 165 items it want to change — this includes not paying out for patients who fall in hospital ward.

The list of planned changes originally included a clause that Medibank Private would not have to pay out if a woman died in childbirth. These matters might be predictable fare in what were once discreet negotiations.

But with AMA chief Owler directly criticising the controversial clause, Medibank Private’s negotiation tactics suddenly looked crude, if not pitiless.

Yesterday Medibank Private appeared to have backed down on the issue with a spokesman claiming there had been a “misunderstanding”.

Nonetheless, opinion remains divided on the broader capability of Medibank Private management. Two brokers, Citi and Macquarie, believe Medibank Private will weather the storms. They see these issues as predictable early-stage battles for a newly privatised company. They suggest claims growth at Medibank Private will moderate and the company will be able to get industry leading margins. Macquarie suggest a target for the stock of $2.65.

In contrast, those negative on the stock — such as Morgan Stanley with a target of $1.85 — suggest growth is under pressure, margin expansion is unlikely and the first annual results (due next month) are “unlikely to inspire”.

Meanwhile, regulatory risk can also have an upside. As discussions among state leaders over the funding of health reach a key juncture after this week’s COAG meeting, the suggestion from Labor premiers in Victoria and Queensland to double the Medicare Levy to 4 per cent would surely see a new wave of Australians moving to private health cover, but without a catalyst of that magnitude Medibank Private will continue to be a disappointment for shareholders who joined the float.