Discover(y)ing the Benefits

Discovery Ltd Stock Analysis

Discovery definitely ticks the great company box, which makes us want to invest in it off the bat. But how does it weigh up as a value prospect? Is it cheap or expensive? And what are the risks? Lets dive in. 

About

Discovery Limited is a South Africa-based, integrated financial services group. Discovery's core purpose is to make people healthier and to enhance and protect their lives. The company currently has roughly 12,650 employees and operates in three major regions: South Africa, the UK, and its global division.

Discovery was co-founded in 1992 by Adrian Gore and Barry Swartberg. 30 years down the line and Gore is still serving as CEO, which is an amazing feat. Rand Merchant Investment Holdings is currently the biggest shareholder with 25.01% ownership, whilst co-founders Gore and Swartberg hold 7.77% and 3.98% respectively. Having a co-founder still serving as CEO (with a 7.77% ownership stake) is super bullish from an investors point of view.

Business

Discoverys products and services include 

• Health insurance: Medical scheme and managed care provider.
• Life insurance: Life, capital disability, income protection, severe illness and funeral cover.
• Investments: General asset management services
• Short-term and commercial insurance, such as car and house insurance
• Banking: Discovery Bank, which launched in 2019.
• Behaviour-change programmes: Vitality offers users an interactive experience that rewards them for positive behaviour. 

In South Africa, it offers Discovery Health, Discovery Life, Discovery Invest, Discovery Insure and Discovery Bank. In the United Kingdom, it offers VitalityHealth, VitalityLife, VitalityInvest and VitalityCar. The global division consists of insurance and health partnerships across the globe.

Revenue breakdown:

Discoverys Health and Life segments constitute roughly 90% of the operating profits generated in 2021. Investments and short-term insurance cover the remaining 10%, whilst the banking division is still loss-making.

Breakdown per region and division:

SA 73%

• Health: 30%
• Life: 33%
• Invest: 10%
• Insurance contributed only 0.3%, as this segments operating profit dropped by 86% for the year due to adverse weather conditions and motor parts inflating dramatically.

UK 21%

Currently, only Vitality Health and Vitality Life are properly underway and generating profits.

• Health 15%
• Life 6%

Global 6%

• Group 4% (rest of the world)
• Ping An 2% (China)

Financials

For an insurance company, we often look at operating profit as opposed to revenue generated. The reasoning behind this is due to cost of sales varies quite a bit depending on the claims paid out during that financial year.

Discoverys profit is mainly dependent on two factors: Income generated, and claims paid out. Income generated is a function of the number of clients and the products that they spend money on, and claims paid out are a function of the overall health of the citizens of a country.

This is where the Discovery Vitality business model comes into play: They have a direct incentive to increase the overall well-being of their users, as this will directly lead to fewer insurance claims. If they can get you to exercise regularly, eat healthily, and drive safely, it will directly improve their bottom line.

For the six months ended 31 December 2021, operating profit increased by 8% to R4 872 million and headline earnings increased by 26% to R2 876 million. New business grew by an average of 6%.

The Balance sheet and Cash Flow statement have no surprises. Debt looks very much under control: The current ratio is strong at 3.32, and Debt to Equity is 38.54%.

Discovery is currently generating an ROE of 10.92%, and trading at a PE of 18.8 and P/S of 1.03. Though this is relatively high compared to competitors like Sanlam and Old Mutual, investors are paying a premium for the potential that Discovery holds, especially with regards to their Vitality programme, new Banking segment and international growth.

Bullish arguments:

• Switching costs: There are a few companies that are known for having extremely high switching costs. Once you go Apple/Woolworths/Discovery, you never go back. The reason for this is high-quality products, excellent customer service, and integrated products/services. 
• Vitality: Offers an interactive, gamified experience to healthy living. One of the biggest contributors to the MOAT of Discovery. When it comes to benefits, Discovery is unmatched.
• Post-covid era: Covid was a nightmare for health and life insurance companies. Now that a large majority of users are vaccinated and new covid variants are losing steam, things are returning back to normal.
• UK and global expansion Vitality Health in the UK was the biggest growth segment (+44%) for the company in 2021. Vitality is working well abroad, which means the potential for expansion is pretty significant. 
• Discovery Bank: Whilst the Bank segment is still operating at a loss, the loss was 18% lower than the prior period. The Bank continued to gain traction with 385,200 clients (versus 287,182 clients in December 2020) and 793,215 accounts (versus 540,252 accounts in December 2020).

Risks:

• Insurance companies raided: The Competition Commission recently raided the premises of eight long-term insurance companies that are suspected of price fixing. The commission said it has reasonable grounds to suspect that those companies, which includes Discovery, colluded to fix prices and trading conditions. 
• Competition: Whilst Discovery as a company offers excellent services, it is trading at a premium relative to its competitors. If the company cannot deliver on expectations, share price retractions are inevitable.

FinMeUp is taking a position in Discovery in our demo account. We believe that the company will continue to deliver excellent services to its clients and strong results to its shareholders. We are taking a solid position for the long term.

Just a friendly reminder - This is not financial advice. Always do your own research before taking a position. Content is for informational and educational purposes only.