Discovery 9 month trading update

On Friday Discovery released a trading statement for the nine months ended 31 March 2011. Now this is a company that has done fantastically well over the last 3 years. In fact they have nearly doubled in market cap since June 2008 trading at around R20 then to around R38 currently. This often means that investors have high expectations whenever numbers are released. Well, it looks like they are managing to maintain that upward trend with some good looking growth expected.

Remember they made the acquisition of the Standard Life healthcare division in the UK so we have to look at adjusted headline earnings per share. These are going to be more than 20% higher than the prior period according to the update. This prior period being the 9 months of last year's financial year. Last year Discovery made R2.78. Assuming they manage to maintain the 20% growth rate we should be expecting around R3.34 for the full year ending June 2011. Trading at R38.14 the company looks cheap. Trading at a PE of 11.4.

I suppose everything is looking cheap at the moment. Although the company has managed to carry on with its earnings growth, market sentiment has done nothing for the share during 2011. So is the market right in thinking that things will slow down for everyone next year? That is the million dollar question I guess. I often advocate that the market is very rarely wrong. But, when it comes to overall sentiment, such instances can create great buying opportunities.

Back to Discovery. Focusing on their South African division management seems upbeat. Total medical scheme memberships surpassed 2.5 million lives. That is very impressive considering the amount of people in SA who cannot afford such a luxury. This was due to low lapse levels and the acquisitions of large closed schemes. Retail assets under management grew to R16.5bn. Discovery Insure was launched during this period and the results of that are yet to take affect but it will be interesting to see how it pans out. When they commit to something, especially locally they normally do it properly so I would expect positive results.

Internationally much focus is on operational efficiency. A lot is still needed to be done for their international aspirations to bear fruit. Scale, relevance and profitability are the main focuses in the UK. Operationalising the JV's in China and the US is the main focus in those areas. Their international operations have not exactly been successful in the past but again it looks like management are doing things properly this time, they have probably learnt from their previous mistakes.

Investment case. We like discovery, it is not amongst our core recommended stocks but we like the healthcare sector and they have a fantastic management team who have really dominated medical aid locally. I'd say that the biggest deterrent would be their business model as an insurer. Insurance companies are very volatile and although they do well during the good times, can really struggle when things slow down. You need a strong stomach to invest in these companies.

Secondly where is the growth going to come from? In the health care sector the South African market looks quite saturated. The growth will have to come from their international operations and new local products. Whether management can pull these off is what you are banking on. Like I said before, management has a fantastic reputation and you would have to back them to perform. At these levels I would be happy to add to the share if you are looking for something slightly different.