Few monthly expenses grate as much as private health insurance. When you’re rarely sick, paying hundreds of dollars each month in insurance hurts.
Fortunately, my parents hammered the importance of health insurance into me. So, like millions of Australians, I duly pay the premiums, occasionally claiming for items.
The premiums keep rising, as does the out-of-pocket expenses for health costs. Our relatively expensive health insurance barely scratched the surface with the kids’ orthodontist bills. Going to the dentist seems like a bigger financial pain these days.
Which brings me to health-insurance stocks. I’ve mostly avoided this sector over the years, principally because of long-term structural headwinds, such as an ageing population lifting demand for health services, and younger people dropping out of health insurance.
Regulatory risk is another factor. Federal government reforms to make health insurance simpler and more affordable – and encourage younger people to take or keep their cover – are designed to aid the sector’s profitability. But relying on government reform creates uncertainty.
Australia’s private health insurance industry has had declining profitability over the past five years, says business forecaster IBISWorld. That’s despite higher premiums in that period supporting industry revenue growth. Rising healthcare demand and costs – and volatile returns in financial markets – have weighed on industry profitability.
COVID-19 has been good and bad for health insurers. Delays in non-urgent elective surgeries last year meant fewer healthcare procedures and cost savings for health insurers. But in recognition of the potential savings, some health insurers deferred premium increases for six months, or offered discounts to members experiencing hardship during the pandemic.
Longer-term, I wonder if COVID-19 will encourage more people, particularly younger ones, to drop their health insurance. Those who lost their jobs during the pandemic, or rely on less-secure casual work, will look for cost savings. Health insurance seems like an easy cut.
Older members might question why they have health insurance when premiums and out-of-pocket expenses keep rising. Also, if there are fewer benefits in having health insurance when members are having to wait longer for procedures.\
Clearly, there are challenges for long-term investors in health insurance providers. But every stock has its price and some health-insurance stocks look interesting.
Sector leader Medibank Private (MPL) is up from a 52-week low of $2.45 to $3.28. Over five years, Medibank has disappointing annualised total return of 6%, Morningstar data shows.
Medibank looks neither cheap nor expensive at the current price. It’s fairly valued and hard to get excited about, despite management doing a reasonable job in a tough industry. I prefer mid- and small-cap health insurers. Here are two to consider:
1. NIB Holdings (NIB)
The market has a negative view on NIB. Barely any of 10 or so broking analysts who cover NIB have a buy recommendation. That’s a good sign for contrarians who have a strong view on the stock and like to bet against the market.
The consensus views seems to be that NIB, like other health insurers, benefitted last year during COVID-19 as elective surgeries were deferred and more people kept their insurance.
As life returns to normal (excluding in New South Wales and possibly Victoria, as I write this column), healthcare demand and costs will rise. In this scenario, investors are better off owning shares in hospital companies (that provide elective surgeries) and other medical service providers.
I’m not so sure. There’s no doubt that NIB’s profit margins have been boosted by COVID-19 and are unsustainable at current levels. But even if NIB’s net insurance margin reverts to it long-term average (about 6%) from 8.3% in the first half of FY21, the business looks attractive.
In April, NIB upgraded its underlying earnings forecast to $200-$255 million. That was better than the market expected and implied a strong second half in FY21 for NIB. Its shares rallied from $5.83 at that announcement to $6.41 (and are well-up on the 52-week low of $4.06).
Clearly, the tailwinds NIB experienced during COVID-19 are short term. But they could last longer than expected. The market is too bearish on NIB at the current valuation. NSW’s COVID-19 outbreaks show the fight is far from over. Health insurers should benefit from rising premiums, more people keeping their insurance and slightly fewer procedures in FY22.
Over three years, NIB has returned an annual 8%, underperforming the market. There’s plenty of room for catch-up. Longer term, NIB is a high-quality business with a strong market position in younger members, who have more years of policy premiums ahead (and less healthcare demand because they are healthier on average than older people).
It wouldn’t surprise to see another leg in NIB’s re-rating after the market digests its recent share-price gains. As analysts upgrade their forecasts – and the consensus view become less bearish – demand for NIB shares should increase.
Chart 1: NIB Holdings (NIB)
Source: ASX
2. iSelect (ISU)
A few years ago I called iSelect to get a better deal on health insurance. The process couldn’t have been easier. iSelect’s recommendation reduce our premiums and increased our policy benefits.
In my case, iSelect offered a good service for consumers. For investors, the stock has been a disaster. The five year-annualised total return is almost -19%.
For a time, the market couldn’t get enough of iSelect when it listed in 2013 on ASX through an Initial Public Offering at $1.85 a share. iSelect was capitalised at almost $480 million at listing.
Today, iSelect is worth $95 million. After trading above $2.20 in early 2017, iSelect hit a 52-week low of 18 cents. They now trade 43 cents due to renewed interest in the stock.
iSelect had a litany of problems. It was fined for misleading advertising, lost its CEO, had falling website traffic and terrible marketing. For a digital business, iSelect had trouble attracting people online and converting leads to sales. Customer numbers tanked.
Fund managers who owned iSelect dumped the stock and cut their losses. Analysts stopped covering it. The media almost forgot iSelect existed, having written negatively about it for years.
iSelect’s best hope was a takeover from rival Compare The Market, which has a 29% stake through its owners, Morningstar data shows. The Australian Competition and Consumer Commission (ACCC) in April said it did not oppose Compare the Market’s owners increasing their stake in iSelect (to 35%, after acquiring another 6%).
With or without takeover, iSelect is interesting at the current price. For all its problems, the company still has a trail commission asset (ongoing fees that iSelect gets from previously sold insurance policies) valued at $118 million on its balance sheet at end-June 2020.
After subtracting liabilities, the trail commission asset alone is worth more than iSelect’s market capitalisation. That implies the market is ascribing little or no value for iSelect’s operating business, brand, customer relationships and so on. iSelect’s recent distribution agreement with health-insurance giant Bupa is another good sign.
A market overlooking good news is what happens when investors give up on a stock. It probably explains why Compare The Market’s owners are increasing their iSelect stake. No doubt they, too, realise iSelect is undervalued at the current price.
Some good judges in microcap stocks – Microequities Asset Management and Thorney International – have increased their stake in iSelect. As so often happens, the smart money moves into an unloved micro-cap before others realise the potential.
iSelect suits experienced investors who understand the features, benefits and high risks of contrarian investing in troubled microcaps. The company still needs a lot of work to restore market trust, but its share price is starting to head in the right direction.
If management can’t turn iSelect around, there’s plenty of capital on the register that can take the company private, fix it and restore value for long-suffering shareholders.
Chart 2: iSelect (ISU)
Source: ASX
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at July 14, 2021.