EUR 850.00 For Business Accounts Only

Morningstar | NIB Surprises with Stronger-Than-Expected Earnings Growth; FVE Unchanged at AUD 6.20. See Updated Analyst Note from 13 Aug 2018

Fast-growing, narrow-moat private health insurer, NIB Holdings, surprised with an uplift in fiscal 2018 earnings guidance, primarily due to lower-than-expected claims costs. NIB now expects group underlying operating profit, or UOP, to be approximately AUD 184 million, up 20% on fiscal 2017, and group statutory operating profit of approximately AUD 169 million, up 12% on fiscal 2017. NIB defines UOP as profit before amortisation, interest expense, investment income, and income tax. Updated UOP guidance was 8% higher than our previous forecast and we now forecast UOP and statutory operating profit in line with guidance.

Our positive long-term view on NIB is supported by the stronger-than-expected outlook for fiscal 2018. Despite recent market volatility, the stock is fairly valued, trading in line with our AUD 6.20 valuation. Despite increasing our fiscal 2018 earnings forecasts, our valuation is unchanged as longer-term forecasts are intact. Our fiscal 2018 earnings forecast increases to AUD 132 million from our previous forecast of AUD 122 million, suggesting a second-half NPAT of AUD 61 million and a final fully franked dividend of AUD 12 cents per share. Fiscal 2018 financials are due Aug. 20. Our total dividend forecast for fiscal 2018 of AUD 21 cps is 11% higher than fiscal 2017 and represents a payout of 70%--the top end of the firm's 60%-70% target range. Longer term, we expect the payout to average 69% per year.

Management now expect Australian resident health insurance, or arhi, net margins of approximately 6.9%, above previous guidance and long-term trends. CEO Mark Fitzgibbon noted, “international students and workers health insurance businesses have also exceeded our expectations.” Tighter cost containment, medical device price reductions and some downgrading in cover underpinned lower growth in claims inflation. The insurer highlighted soft economic conditions as contributing to lower growth in the volume of medical, dental and other treatment.

The arhi business expects to pay AUD 1.46 billion in claims in fiscal 2018 up only 4% on fiscal 2017, despite organic policyholder growth of 3%. Lower claims growth will likely result in lower industrywide policyholder premium rate increases effective April 2019. NIB Holdings' 2018 premium rate increase of 3.95% was the lowest in 15 years. We expect industrywide private health insurance premiums to grow in the 3%-4% range per year until 2022.

Previous fiscal 2018 guidance was a group underlying operating profit of at least AUD 165 million and a group statutory operating profit of at least AUD 148 million. Guidance is for arhi organic growth of 3%-4%. The fiscal 2018 arhi net margin was guided to be at the high end of 5%-6% range. Management expects fiscal 2018 investment returns to be in line with internal benchmarks and the ordinary dividend payout ratio of 60%-70% of full-year NPAT. Management expects the arhi net margin in fiscal 2019 to move back towards the top end of the 5%-6% range.

We now expect fiscal 2018 to be another impressive growth year, an uplift from our previous position of fiscal 2018 being a “consolidation year.” Fiscal 2016 and 2017 delivered EPS growth of 23% and 28%, respectively, and we now expect fiscal 2018 EPS to increase 11%. From fiscal 2019, we forecast strong earnings growth with EPS set to grow an average of 12% per year until fiscal 2022. NIB's recent acquisitions and key "partners" distribution agreements have started contributing to net policyholder growth and profitability. The recently announced acquisition of QBE Insurance Group's travel insurance business for AUD 25 million is not incorporated in the earnings upgrade as the transaction is not expected to complete until first-quarter calendar 2019. Financial impacts will be limited and will be reported in NIB Holdings' second-half fiscal 2019 results.

The arhi business is the core profit contributor for the group, accounting for 70% of group NPAT in fiscal 2017, with adjacent businesses includes travel insurance, international workers and student health insurance and New Zealand making 30%. We like management's diversification strategy and the goal to increase adjacent business contribution to approximately 50% of group earnings. We like the consistent execution of organic growth strategy and small bolt on acquisitions.

NIB Holdings is a capital-light business with minimal capital expenditure requirements. Cash flow is primarily available for reinvestment in new businesses or acquisitions with the balance paid to shareholders. The high P/E is justified given little capital is required to run the business. The addition of the 3.6% dividend yield and our 12% forecast average annual cash EPS growth rate equates to approximately 16%--a broad estimate of future annual returns. NIB Holdings is trading around 19 times forecast fiscal 2019 earnings, broadly in line with industry heavyweight Medibank Private.

Management continues to improve the business fundamentals with the group health insurance underwriting profit margin steadily increasing to 8% in fiscal 2017 from 5% in fiscal 2014. We expect this key earnings driver to increase to 9.2% in fiscal 2018 and stabilise in the 8%-8.5% range to end fiscal 2022. Key risks to our positive view include unfavourable political outcomes, particularly around annual government-approved premium increases, weak industry growth rates due to unaffordability, margin pressure, and increased investment need across the business. Acquisition and integration risks remain for the acquisitive private health insurer. We have allowed for these risks in our base case valuation, assuming premium growth around 3%-4% per year, slow growth in policyholder numbers and margins falling modestly from fiscal 2019. Acquisition and integration risk is difficult to gauge, but to-date, the health insurer has a good track record with acquisitions.