Sunday, April 28, 2013

Why I Still Own WLP

Wellpoint reported earnings of $2.94 for the first quarter 2013. This is an excellent start for the new CEO Joe Swedish. If we project this earnings to a full year, it is a P/E of about 6! However, for some reason, WLP projects earnings to be $7.75 only. I am not sure why. The company did say integration costs of Amerigroup will be a drag on earnings. Still at a current price of about $73 per share, WLP is compelling.

WLP is a managed care company. The company has the Blue Cross/Blue Shield license in 14 states. Late last year, the company agreed to buy Amerigroup, a Medicaid manager, for $4.9B.

Last year I was bullish on WLP because it suffered from several big headline events. First was Obamacare's victory in the Supreme Court. Most had expected the mostly Republican Supreme Court to strike down Obamacare. Second was disappointing earnings for Q2 2012. Shortly after that, then CEO Angela Braly left. The following chart shows these events' affect on the share price. WLP was normally a stock with a P/E less than 10, and then in Fall of 2012 it drops more than 33% following two events.

Shortly after these events, WLP issued more debt and bought back more stock. That is a great idea. The company get debt at around 2.75% interest and get stock that yields 15%. In addition, WLP bought Amerigroup. And last quarter earnings shows that WLP at the moment is a cash cow.

Still the biggest overhang on the business is Obamacare. In October, as part of Obamacare, all states will implement exchanges. Exchanges are government run marketplaces where individuals and business can go to compare policies and premiums. Note that all this does not necessarily mean that the government will compete with managed care companies like WLP. In fact based on what I understand of government and healthcare, the government likes to outsource management. For example, more than 70% of all Medicaid enrollees use managed care companies like Amerigroup. With the expansion of Medicaid and insurance coverage overall, managed care companies now have 30 million more potential customers.

The flip side is fear of government regulation. Right now, government restricts benefit expense ratios to be 85% or less. Wellpoint's ratio is 86%. So it is within reasonable limits.

I am purposely being vague in my analysis of the Obamacare situation, because Obamacare is a confusing topic. It affects almost everyone in America yet I don't think the majority knows how it will affect them come October. How it will play out is very unclear, regardless of whether you are a lobbyist, politician, doctor or a WLP executive, we are all pretty much in the dark. But, to me, managed care companies have tremendous potential and WLP in particular has a huge margin of safety.

In my post last year, I listed some negative headline events that unnecessarily depressed decent large cap stocks. I participated in some of these events, namely Philip Morris. Now, the future will tell if Wellpoint is another. If it is, then I believe the WLP bears will capitulate when the dust begins to settle on Obamacare. That could take two to three years. By that time, who knows, WLP could double.

No comments:

Post a Comment