Missouri-based Centene Corp. (CNC, Financial), the $14.5 billion health care plans provider, reported an impressive 68.6% increase in its total revenues to $11.72 billion and profits of $139 million in the first quarter compared to losses of $16 million in first-quarter 2016.
As observed, Centene’s premium revenue nearly doubled at 1.8 times year over year to $10.64 billion representing 90.7% of total company sales therefore leading to better bottom-line figures.Â
Nonetheless, the care plan provider recorded 75.5% higher medical costs at $9.3 billion and 51.1% higher general and administrative expenses at $1.1 billion in the same time period. These figures reflect somewhat similar high 30% to 80% growth rates in first-quarter 2016.
Centene also provided its fiscal 2017 guidance, which at midpoint comparison to 2016, indicated growth rates of 14.3% in revenue to $46.4 billion and 15.2% in earnings per share (EPS) to $3.95.
“We are pleased with the operating results for the first quarter, providing momentum for the remainder of the year."Â –Â Michael F. Neidorff, Centene chairman and CEO
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Valuations
Centene is slightly undervalued compared to its peers. According to GuruFocus data, the insurer had a trailing price-earnings (P/E) ratio of 20.28 times vs. the industry median 21.08 times, a price-book (P/B) ratio of 2.39 times vs. the industry median of 2.7 times and a price-sales (P/S) ratio of 0.33 times vs. the industry median of 0.64 times.
Centene has not paid any dividends in the past decade.
Average 2017 sales and EPS expectations indicated forward multiples of 0.33 times and 17.7 times.
Total returns
Centene has outperformed the broader Standard & Poor's 500 index in the past 15 years with (annualized) 21.2% total returns compared to the index’s 8.4% (Morningstar). The company has provided 48.91% total returns so far this year compared to the index’s 9.98%.
Centene
Centene was founded in 1984. According to filings, Centene is a diversified, multinational health care enterprise that provides a portfolio of services to government-sponsored health care programs, focusing on underinsured and uninsured individuals.
The insurer provides member-focused services through locally based staff by assisting in accessing care, coordinating referrals to related health and social services and addressing member concerns and questions.
In March 2016, Centene acquired Health Net for $5.99 billion. According to filings, Health Net delivers health care services through health plans and government-sponsored managed care plans.
As of March, Centene’s managed care membership grew 5% year over year to 12.1 million.
Centene operates in two segments: Managed Care and Specialty Services.
Managed Care
Centene’s Managed Care segment provides health plan coverage to individuals through government-subsidized programs including Medicaid (1) that also encompasses the state Children's Health Insurance Program, Long Term Care, Foster Care, dual-eligible individuals, the Supplemental Security Income Program, also known as the Aged, Blind or Disabled Program, Medicare and Health Insurance Marketplace.
The Managed Care segment also includes the operations previously included in Health Net's Western Region Operations Segment, with the exception of certain operations of its pharmaceutical services and behavioral health subsidiaries. The portions of Health Net's Western Region Operations segment included in the Managed Care segment consist of the following Health Net operations: commercial, Medicare, Medicaid and dual eligible health plans, primarily in Arizona, California, Oregon and Washington.
In the recent quarter, revenue in Centene’s Managed Care business climbed 69.8% year over year to $11.1 billion (79% of total unadjusted sales) and delivered $187 million in earnings (1.7% margin) compared to $19 million in losses the same period last year.
Specialty Services
Centene’s Specialty Services segment consists of specialty companies offering diversified health care services and products to state programs, correctional facilities, health care organizations, employer groups and other commercial organizations as well as to Centene’s own subsidiaries.
The Specialty Services segment also includes the operations previously included in the Government Contracts segment of Health Net as well as certain operations of its pharmaceutical services and behavioral health subsidiaries, the latter of which Health Net previously included in its Western Region Operations segment.
The Government Contracts business includes Centene’s government-sponsored managed care support contract with the Department of Defense under the TRICARE program in the North Region, the Military Family and Life Counseling contract with the Department of Defense and other health care-related government contracts including the Patient Centered Community Care with the VA.
In the first quarter, revenue in the specialty services grew 56.2% to $2.94 billion (20.9% of total unadjusted sales) and delivered a margin of 1.8% compared to 2.1% in first-quarter 2016.
Sales and profits
In the past three years, Centene recorded revenue growth average of 55.2%, profit growth average of 50.4% and profit margin average of 1.5% (Morningstar).
Cash, debt and book value
As of March, Centene had $4.8 billion in cash and cash equivalents and $4.65 billion in debt with a debt-equity ratio of 0.77 times vs. 0.8 times in the same period last year. The insurer added $367 million in debt while shareholder equity, mostly through retained earnings, increased by $761 million. Total share count has increased by 1.8 million.
Of Centene’s $21.4 billion assets 29%Â were identified as goodwill and intangible assets. The care plan provider grew its book value by 14% to $6.22 billion year over year.
Cash flow
In the recent quarter, Centene’s cash flow from operations jumped 6.4 times to $1.25 billion year over year. In addition to recording profits, Centene recorded higher and positive cash flows in its receivables, medical claims liabilities, unearned revenue and other operating activities.
Capital expenditures were $83 million leaving Centene with $1.17 billion in free cash flow compared to $151 million in first quarter 2016.
Centene used 1.1% of free cash flow to repurchase its shares for $67.17 per share – 20.2% discount from the share price of $84.15 (at the time of writing). In the fourth quarter of 2016, Centene repurchased its shares for $56.8 per share.
Centene has about 3.34 million remaining shares left to repurchase according to its 2009 buyback program as of the recent quarter. On average, Centene allocated 5.7% of its free cash flow in share buybacks in the past three fiscal years.
The care plan provider also took in $3 million in debt, net any repayments and other financing activities.
Conclusion
Centene’s acquisition of Health Net has been a good outcome in both the top and bottom lines as manifested in the first quarter and as expected in fiscal 2017. Nonetheless, Centene exited its Health Net business in Arizona in January and withdrew its contracts with five nonprofit regional care organizations in Alabama in February due to uncertainty in the political environment.
Centene exhibited strong balance sheet condition in which it could pay all of its debt with its current cash holding while having maintained a disciplined buyback program since 2008.
Nineteen analysts have an average price target of $83.47 compared to today’s share price of $84.15 (at the time of writing). Assuming a 14% revenue growth and applying a three-year average P/S multiple followed by a 20% margin indicated a value of $15.47 billion or $89.8 a share.
In summary, Centene is a hold with an $84 per share target price.
Notes
(1) Company filings
Medicaid
Established in 1965, Medicaid is the largest publicly funded program in the U.S. and provides health insurance to low-income families and individuals with disabilities.
The majority of funding is provided at the federal level. Each state establishes its own eligibility standards, benefit packages, payment rates and program administration within federal standards. As a result, there are 56 Medicaid programs – one for each U.S. state, each U.S. territory and the District of Columbia.
Eligibility is based on a combination of household income and assets, often determined by an income level relative to the federal poverty level. Historically, children have represented the largest eligibility group. Many states have selected Medicaid managed care as a means of delivering quality health care and controlling costs.
CMS estimated the total Medicaid market was approximately $545 billion in 2015 and concluded the market will grow to $973 billion by 2025.
Medicaid spending increased by 9.7% in 2015 and is projected to increase at an average annual rate of 5.9% between 2016 and 2025
We (Centene) believe a significant market opportunity exists for managed care organizations with operations and programs focused on the distinct socioeconomic, cultural and health care needs of the uninsured population and the Medicaid, CHIP, LTC, Foster Care and ABD populations.
Disclosure: I do not have shares in any of the companies mentioned.
