We’ve seen our fair share of earnings season winners this August. Endeavour and NIB weren’t two of them. The market dumped both shares on Monday after earnings but, according to our analysts, the sell-off was overdone.

NIB Holdings Ltd (NHF)

  • Economic moat: Narrow
  • Star Rating: ★★★★
  • Uncertainty Rating: Medium

Why did NIB shares crash?

NIB is Australia’s fourth-largest private health insurer. The company reported a big miss on underlying profits and the shares shed 17% of their value.

Morningstar’s Nathan Zaia says that NIB’s profit margins in private health insurance normalised more quickly than was expected, while the earnings outlook for international students is also weaker.

Underlying net profit after tax increased by 3% to AUD 196 million, a hefty 16% miss against Zaia’s forecast. Even adding back around AUD 22 million in one-off costs, NIB’s profits were still 7% below what he was expecting.

Margins always looked likely to fall

NIB has been overearning in recent years thanks to fewer hospital admissions and dental claims during and after the pandemic.

In that sense, Zaia says the fall in margins was always a matter of when, not if. But the pace of the decline in margins – down to 6.7% in the second half from 9.7% in the first - seems to have caught investors off guard.

A 6.7% margin sits within management’s long-term target range and Zaia doesn’t think the faster-than-expected compression in margins changes NIB’s long-term outlook. Yet there’s no getting away from the fact that investors were hoping for longer period of elevated profits.

NIB’s other divisions didn’t exactly pick up the slack. Its international business faces headwinds from lower foreign student numbers in fiscal 2025, while the New Zealand business needs substantial premium increases to restore margins.

These factors led Zaia to cut his Fair Value by 6.5% to $7.20 per share – a considerably more optimistic assessment than that of the market.

The long-term view on NIB

Zaia thinks NIB can continue to take market share in its core private healthcare business. He expects the firm to grow its number of policyholders at around 2% per year between fiscal 2025 and 2029, almost double the rate of growth he expects for the broader sector.

These market share gains are expected to be helped by NIB’s cost advantages over smaller peers.

NIB’s existing 10% share of the market gives more bargaining power with healthcare service providers than smaller peers. As well as allowing NIB to keep up with most peers on price and policy features offered, this frees up funds for NIB to leverage its brand and advertising budget to attract customers directly.

In addition to cost advantages, Zaia’s Narrow Moat rating for NIB is also underpinned by the presence of switching costs for existing policyholders. The wide range of choices in the market discourages consumers from switching due to the time required to compare different options. Meanwhile, waiting periods of up 12 months which must be served out before being able to claim for some extra services.

NIB also uses retail brokers and white-label partners to grow its policyholder base. The use of non-direct sales channels and introductory bonuses such as gift cards is likely to bring higher acquisition costs and lapse rates than larger peer Medibank. But Zaia sees merit in the strategy as NIB looks to grow share and reap more cost advantages from its growing scale.

At a share price of $6.13, NIB shares currently trade around 15% below Zaia’s Fair Value estimate and command a four-star Morningstar Rating.

Endeavour Group Ltd (EDV)

  • Economic moat: Wide
  • Morningstar Rating: ★★★★
  • Uncertainty Rating: Low

Endeavour is Australia's leading omnichannel liquor retailer, operating the largest network of brick-and-mortar stores in the country across the well-known Dan Murphy's and BWS brands.

Endeavour also has substantial interests in hotels and electronic gaming, operating more than 12,000 gaming machines across its portfolio of over 300 hotels, pubs, and clubs. Around 85% of Endeavour’s sales and 65% of its pre-tax earnings come from the liquor retailing segement.

Why did Endeavour shares fall?

Endeavour’s fiscal 2024 earnings were largely in line with our analyst Johannes Faul’s expectations. Net profits for the year of $512 million were just 1% off his forecast, and retail liquor sales growth of 2% was weaker than previous years but faster than the broader industry.

In his research report, Faul also noted that the company dealt well with a year of high wage inflation, keeping its operating profit margins steady. Albeit with lower net profits due to higher interest expenses as a result of higher rates.

Now for the part that markets didn’t like so much. Endeavour pointed to a weaker than expected start to fiscal 2025, with retail liquor sales up by 1% and revenue for hotels up by 2% compared to the same seven weeks last year.

Faul still expects sales momentum to improve in fiscal 2025 but by less than before. He reduced his sales growth estimate for Endeavour from 6% to 4%, but this wasn’t enough to impact his $6.10 Fair Value estimate for the shares.

Consumers seem to be prioritising better value options —like larger packs in shops or cheaper dishes in pubs—as mortgage payments and other expenses cut into household budgets. Faul thinks Endeavour’s big box retailer Dan Murphy’s is well-placed for this shift. And he continues to prize Endeavour’s strong position in the liquor retailing business, which has been resistant to economic downturns in the past.

The long-term view on Endeavour

Endeavour controls 47% of Australia’s off-premise liquor market through its BWS and Dan Murphy’s brands, which have a combined 1,600 outlets throughout Australia. This makes Endeavour significantly larger than its closest integrated peer Coles Group (which has an estimated 17% of the market) and almost twice as big as Metcash’s base of customers.

Endeavour’s dominant scale allows it to fractionalise distribution, administration, and marketing costs in a way that smaller competitors cannot. This has translated into Endeavour maintaining a materially higher level of operating margins than its peers for several years. Endeavour has also grown its liquor sales faster than Coles Group.

Moreover, Faul thinks the immediacy of alcohol consumption and Endeavour’s extensive brick-and-mortar network make Endeavour less susceptible to online disruption from players. Most customers don’t want to wait for online delivery, while Endeavour’s retail footprint offers a huge choice of click and collect venues to customers.

Faul expects consumer demand for alcohol to be relatively steady through the economic cycle, exhibiting attributes of consumer defensives. The Australian hotels market will predominantly be driven by the same factors as the off-premises retail liquor market, namely population growth and inflation.

How much might Endeavour be worth?

Faul thinks Endeavour can grow its overall revenue and pre-tax earnings at a 5% annual clip – including 4% annual growth in liquor retailing.

His Fair Value estimate of $6.10 per share implies an EV/EBITDA ratio of 8, a P/E ratio of 23, and a dividend yield of 4% which he expects to be fully franked.

Faul says this places Endeavour's dividend yield broadly within the upper and lower bounds of Coles' and Woolworths' respective dividend yields. This seems reasonable as all three firms are mature, low growth, dividend-oriented companies in the defensive staples sector.

He does note, however, that Endeavour differs from Woolworths and Coles given its exposure to regulatory risks surrounding gambling, and to a lesser extent, alcohol.

Remember – individual shares should only be considered as part of a broader investing strategy. Go here for a step by step guide to forming yours.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn more about how to identify companies with an economic moat, read this article by Mark LaMonica.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.