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Can profit margins continue to grow for Medibank Private?

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Key statistics: ASX:MPL

1/03/16 closing share price: $2.580

52 week high: $2.700

medibank-private

Most recent dividend: 5c

Annual dividend yield: 4.09%

Franking:100%

Medibank Private has a vast and long-term opportunity to bring down its claims expense.

With just 2.2% of policyholders responsible for a third of the claims expense, technology and operating leverage could be combined to have a material impact on the margins and profitability of the firm.

At the time of the float, Medibank guided that it will pay around 86 cents of every dollar of premium earned on claims.

This is by far the largest bucket of cost - which implies this is also the largest opportunity to boost earnings. To the extent Medibank can reduce the amount it pays on claims each year - for instance, through smarter healthcare delivery or the employment of new prevention techniques to its customers - then earnings will increase.

While healthcare remains a political football and at risk of policy revision, a profitable and sustainable private health insurance sector is necessary to avoid government adoption of epochal healthcare expenses.

Since the float revenues and profits have grown, as have profit margins. The company has also paid IPO investors a 5.3 cent dividend or a 4% yield.

In January Medibank Private announced a profit upgrade for the first half of the 2016 financial year as a result of a combination of reduced claims expense, improved hospital contracting and a reduction in hospital utilisation growth.

This highlights the scale of the opportunity for efficiency gains in the business, and these gains are being realised more quickly than expected.

While over half of the increase in 2016 financial year operating profit guidance can be considered one off, the upgrade also included an approximate 8% increase in sustainable operating profit for the health insurance business.

Given this improvement, it is not unreasonable to expect some ministers to reignite the debate about premium increases and to appease those that might be displaced, MPL will resubmit to the federal government a lower price increase proposal for 2016.

The decision to revise down its proposed price increase for 2016 is in line with our expectations as we had assumed MPL would need to share some of the efficiency gains with customers. Our forecasts assume 5% price rises between 2016 and 2019.

Medibank private

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Roger Montgomery is founder, chairman and chief investment officer of Montgomery Investment Management. Following a successful career as an analyst and public company chairman, Roger published the first edition of his stock market guide, Value.able, in 2010, becoming an Australian best seller in just 16 weeks. He holds a Bachelor of Commerce and is a senior fellow of the Financial Institute of Australasia.
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