An earnings kicker from the return of immigration

Medibank (ASX: MPL) is a stock that offers strong earnings growth with relatively high certainty compared to the rest of the market. The sell off that followed the cyber incident last year provided a compelling opportunity to enter the stock at attractive valuation levels.

Policyholder numbers are growing again

The widely publicised cyber-attack in October 2022 caused substantial disruption to the Medibank business. Apart from damage to the brand, significant resources were directed away from customer acquisition and retention towards dealing with queries relating to the attack.

In evaluating the potential impacts on the brand and customer growth, we referenced the experience of Optus following its own cyber incident. The Optus attack occurred almost a month before Medibank, on 22 September 2022. Over the subsequent three months Optus post-paid customer numbers contracted by 1.1% (4.3% annualised) but have since returned to pre-incident levels of growth. Medibank policy numbers had only returned to modest growth in February, but we expect this will continue to trend higher as we saw with Optus.

As shown in Figure 1 above, prior to the cyber-attack Medibank was growing policyholder numbers at ~3% per annum. While we would expect cost of living pressures to have some negative impact on private health insurance take-up, we believe there are a number of offsetting tailwinds that should enable Medibank to continue growing, namely:

1. Low claims activity means the recent pattern of premium refunds and premium increase deferrals is likely to continue (see more detail in next sub-section).

2. Public hospital waiting lists are long and not improving.

3. General consumer focus on health has increased post-COVID.

4. In 2023, premium increases will be below wage inflation for the first time in over 20 years.

Slow claims recovery supports margins

Following the deferral and cancellation of claims during COVID, private health insurers made a commitment to the Government that they will not retain any excess profits. To the extent that actual claims have been below underlying, policyholders have received:

1. Deferral of premium rate increases; and

2. Cash refunds of previously paid premiums

Since the onset of COVID, Medibank has provided more than $1 billion of financial support to policyholders through the above mechanisms plus financial hardship support. Despite consistent discussion of the claims ‘backlog’, the gap between actual and underlying claims has been progressively widening. For the six months ending December 2022, actual claims were 9% below underlying.

While Medibank expects a reversion back towards underlying trends over time, there are some claims areas such as rehab where claims behaviours may have changed more permanently.

Prior to COVID, Medibank identified rehab in the home as a key focus area to improve customer experience and reduce overall health system costs. COVID naturally forced a lot of post-operative rehab for procedures like knees and hips into the home, which helped Medibank accelerate this shift. As a result, rehab claims now sit more than 20% below pre-COVID levels and may not revert.

At the February 2023 result, the Medibank CFO stated that “the biggest opportunity for our claims line is on rehab. We’re seeing somewhere around 20% lower rehab referral rates. We're assuming they revert … If they don't, that's a $50-60 million claims saving.” Note that a $50-60 million claims saving equates to a 7-8% net profit after tax benefit, all else equal.

An earnings kicker from the return of immigration

Medibank’s division that insures overseas students and workers has rarely been a focus for investors. However, with the closure and reopening of borders, ‘non-resident’ business is now a reasonable swing factor. Over the year to December 2022, Medibank grew policyholders in this business by 35% which added 5% to group net profit after tax. Continued strong immigration data so far in 2023 suggests this business can continue to surprise positively over the next twelve months

Valuation remains well below pre-cyber levels

Medibank has now bounced around 20% from its lows relative to the market, however the stock still sits 15% below where it was trading prior to the cyber-attack despite an improved earnings outlook.

Our earnings forecasts for Medibank are 7-15% ahead of consensus and we forecast an earnings per share growth rate of 10% over FY23-25. On a multiple of 16x FY24 earnings per share, we believe Medibank is one of the cheapest defensives in the ASX 200.

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