Vitality Limited's Restructuring And Data Focus Will Drive Future Profitability

Key Takeaways

• Restructuring into focused businesses and reduced spending enhances operational efficiency, driving potential profitability and earnings growth.
  
• Discovery Bank's profitability and growth plans significantly boost group earnings, while hyper-personalization strategies enhance client engagement and revenue.
  
• Discovery faces operational complexity and regulatory risks across markets, with challenges in the UK and South Africa threatening revenue, earnings, and margins.

Catalysts

Provides various insurance products and services primarily in South Africa and the United Kingdom.

• Discovery is entering a new high-growth phase with expectations of earnings growth between 15% to 20% annually over the next 5 years, driven by reduced spending on new initiatives and enhanced cash conversion. This impacts both revenue and margins positively.
  
• The restructuring into two distinct businesses, Discovery South Africa and Vitality Limited, enhances focus and operational efficiency, which could drive future profitability and earnings growth.
  
• Discovery Bank is expected to become profitable in the next financial year and has plans to grow its client base to 2 million and profits to ZAR 3 billion by 2029, significantly impacting group earnings and cash flow.
  
• Ping An Health, a subsidiary, demonstrated strong growth with an 85% profit increase, cash flow improvement, and distribution of dividends, contributing positively to Discovery's consolidated earnings and cash reserves.
  
• Discovery's focus on hyper-personalization and data utilization across its products is expected to drive value creation and client engagement, potentially improving revenue streams and operational efficiency.

Discovery Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Discovery's revenue will decrease by 13.3% annually over the next 3 years.
• Analysts assume that profit margins will increase from 9.0% today to 23.2% in 3 years time.
• Analysts expect earnings to reach ZAR 12.1 billion (and earnings per share of ZAR 17.42) by about February 2028, up from ZAR 7.1 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 17.5x on those 2028 earnings, down from 17.7x today. This future PE is greater than the current PE for the ZA Insurance industry at 13.2x.
• Analysts expect the number of shares outstanding to decline by 0.16% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 16.39%, as per the Simply Wall St company report.

Discovery Future Earnings Per Share Growth

Risks

• Discovery operates in multiple countries, each with unique economic conditions, which introduces significant operational complexity and risks that could affect revenue and earnings.
  
• Challenges in the UK related to NHS dynamics have led to increased claims costs for Vitality Health, impacting overall operating profit and potentially affecting net margins.
  
• The financial performance of Vitality Life has been impacted by interest rate changes and the management of an old block of business in the UK, which could strain earnings and margins if not addressed.
  
• High rates of medical inflation in South Africa pose a challenge, with adverse selection accounting for approximately 40% of demand-side inflation, potentially impacting revenues and the net margins of health insurance products.
  
• The NHI bill in South Africa, with potential restrictions on private healthcare funding, presents regulatory risks that could affect Discovery's health insurance business, impacting revenue and profit margins.

Valuation

• The analysts have a consensus price target of ZAR204.272 for Discovery based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ZAR242.0, and the most bearish reporting a price target of just ZAR157.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be ZAR51.9 billion, earnings will come to ZAR12.1 billion, and it would be trading on a PE ratio of 17.5x, assuming you use a discount rate of 16.4%.
  
• Given the current share price of ZAR191.29, the analyst price target of ZAR204.27 is 6.4% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.