Wednesday, August 6, 2014

Time to Reevaluate Wellpoint

Wellpoint just released the company's Q2 earnings. The stock dropped a few percent right after the release. But the results seem fine to me and management upped its 2014 GAAP earnings guidance to $8.81. The stock drop tells me that the market has finally revalued Wellpoint and the entire managed care industry. Two years ago Wellpoint was trading at half of the current $110 price. That priced the company at less than 10 times trailing earnings. Joe Swedish has improved the company's operations and appears to be a very shareholder friendly CEO. Now it is trading at 13 times projected 2014 earnings. This is a multiple expansion is what I had hoped or expected when I last added to my position two years ago.

Now it is a half year after Obamacare's individual mandate and we have a better but still foggy picture of heathcare. This is a good time for me to reevaluate WLP.

Obamacare affects Americans not just through its individual mandate. But the individual mandate is the most controversial and far-reaching part of the legislation. From what I see so far, the uninsured aren't dragged kicked and screaming to get coverage. And the new enrolees aren't just the sick and unprofitable members of the pool. I can tell because the Obamacare first year enrolment exceeded projections. And as further evidence, the California Obamacare insurers plan to raise rates 4.2%, which is less than the healthcare industry overall. This means that the first year rates were adequate and the enrolment mix had enough healthy to cover the unprofitable sick. Remember, Obamacare cannot discriminate the sick from the healthy with different rates.

Another controversial part of Obamacare is the Medicaid expansion. Medicaid expansion under Obamacare raises the level at which a person qualifies for Medicaid. However, each state can opt out if they wish because of the 2012 Supreme Court ruling. So far about half of the states have opted out. However, the most populous of the 14 states where Wellpoint does business are participating in Medicaid expansion. And Medicaid enrolment is up 15% this year compared to last in participating states. Wellpoint should be well positioned with its recent Amerigroup acquisition.

Joe Swedish has been all gung ho on Obamacare since joining Wellpoint more than a year ago. Preliminary facts looks like it will pay off. The medical loss ratio (MLR) is now at 82.7%. The MLR is the ratio of benefits paid to revenue. It is one of the key metrics to measure medical insurance companies. It was at 85% before he took over. And the company bought back 8 million shares in the last quarter alone. Mr. Swedish seems to be really focused on improving the company's bottom line.

Wellpoint recently has been the cheapest of the MCOs because of missteps before Mr. Swedish arrived. But the valuation is catching up. The following table compares all the major MCOs.

Wellpoint Aetna Humana Cigna Unitedhealth
Price 111 78.3 120 91.67 81.5
PE 12.6 12.0 16.0 12.6 14.7
ROE 0.10 0.16 0.12 0.18 0.16
P/BV 1.3 1.9 1.8 2.2 2.4
MLR 82.7% 83.1% 83.1% 84.5% 81.6%

Buying and selling stocks is a balancing act on a scale. In a perfectly efficient market the scale is balanced. I see possible future scenarios that would weigh in favour of holding WLP:
  • Americans increasingly want health care, but are adamantly against government control. Obamacare increases in popularity.
  • Healthcare has great pricing power, costs have been and will be rising significantly above GDP growth.
  • Joe Swedish is the real deal, he will continue to improve the company's operations
  • More Republican states accept Obamacare and actively participate (for example Medicaid expansion). 
But there are risks from possible negative scenarios that can also weight against holding WLP
  • Obamacare enrollment falls to below expectations and causes the enrollment mix to be more skewed towards the sick.
  • The president who takes office in 2017 is Republicans and he repeals Obamacare.
  • Joe Swedish slips and is not as good as the media makes him out to be.
Overall though, I think the negatives are weak and unlikely. The market is still discounting for the uncertainty of Obamacare. The coming years will bring dramatic changes to medical delivery in the US. But still I feel market sentiment is ambivalent towards MCOs. It just isn't sexy. The market doesn't feel it is deep value, and it isn't growth. But who knows, maybe that will change soon. But the positive potentials of gradual but steady growth with all the changes is an opportunity that comes to an industry once in decades, and yet it is so discounted. If the positive scenarios take place as I hope, I think WLP can be $150. So I am keeping my WLP shares.

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