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Morningstar | NIB Upgrades FY19 Earnings Guidance. No Change to AUD 6.20 FVE

Narrow-moat-rated private health insurer NIB Holdings surprised with a positive earnings guidance update for fiscal 2019. The firm continues to benefit from the prolonged benign claims environment, particularly in the core Australian resident health insurance business. Low claims activity for first-quarter fiscal 2019 and a better-than-expected outcome for claims incurred during the 12 months ended June 30, 2018 is reducing claims utilisation to historic lows across the private health insurance industry. NIB Holdings’ CEO Mark Fitzgibbon noted “there’s no doubt macro factors such as negligible wage growth are having an impact in terms of industry participation, as well as the rate of our members are seeking medical treatment.”

The fast-growing insurer has attempted to improve consumer affordability issues around private health insurance, focusing on reducing cost growth, expanding provider networks and passing on in full to its members savings from price reductions in certain medical devices. The firm’s previous fiscal 2019 guidance assumed a rebound in claims utilisation that has not occurred. Previous guidance was based on margins in NIB Holdings’ Australian resident private health insurance business to be at the upper end of the firm’s 5%-6% target range. But due to lower claims utilisation, the margin is now expected to be around the 6.9% reported in fiscal 2018.

The guidance upgrade increases our earnings forecasts modestly as we were already above previous guidance. Despite the positive update, we maintain our AUD 6.20 per share fair value estimate. Our valuation is based on a 9.0% cost of equity and NPAT growing at an average of 9% per year for five years to end of fiscal 2023. At current prices the stock is undervalued, trading 11% below our valuation and is at around 18 times forecast fiscal 2019 earnings. The market responded negatively to the firm’s previous soft guidance issued with fiscal 2018 results in August with the stock down about 20% since.

Consolidated group underlying operating profit (profit before amortisation, M&A costs, interest expense, investment income and tax) guidance for fiscal 2019 has been upgraded to at least AUD 190 million from at least AUD 180 million issued in August. We increase our fiscal 2019 consolidated underlying operating profit forecast to AUD 192 million from our previous forecast of AUD 185 million. If achieved, our fiscal 2019 forecast will be 4% higher than the AUD 185 million achieved in fiscal 2018. Our NPAT profit forecast for fiscal 2019 increases to AUD 140 million from AUD 135 million previously.

Our fully franked dividend forecast for fiscal 2019 increases to AUD 21 cents per share and if achieved will be 5%, or AUD 1 cent per share higher than fiscal 2018. We expect the fiscal 2019 dividend payout to be 68% towards the top of the 60%-70% target range. Capital is becoming more important and we expect the recently implemented dividend reinvestment plan to be maintained. Despite the AUD 25.5 million of surplus capital at June 30, 2018, proposed changes to Australian Prudential Regulation Authority regulatory capital rules could increase future capital requirements for private health insurers. It is too early to assess any potential impact on NIB Holdings and potential changes may take several years to implement. The June 2018 surplus excludes the final dividend, approximately AUD 11 million earmarked for the China JV and up to AUD 36 million to fund the QBE Travel Insurance acquisition, including transactions costs.

We expect a strong performance from the key Australian operations in fiscal 2019 and the first full-year contribution from GU Health that was acquired in September 2017. We continue to forecast good growth in net policyholders, increased market share, benign claims environment, the uplift in net margins, the improvement in the core Australian resident health insurance net promotor score. In addition to the expanded third party health insurance distribution arrangements, we expect higher earnings growth from the noncore businesses, particularly World Nomads, New Zealand and the inbound international workers and students' health insurance.

Growth in the “partners” distribution channel is needed to underpin our forecast volumes. We expect return on equity to remain at impressively high levels around 25% during the next five years despite the higher capital base following the GU Health acquisition and future participation in the dividend reinvestment plan. Negatives included increased uncertainty around future regulatory capital requirements, higher spend on marketing, technology and underwriting expenses, and a modestly softer outlook for dividend growth.