Following UNH’s earnings report and conference call this week, we are revising our outyears estimates upwards to reflect UNH’s ability to manage through potential HIF headwinds in 2020+, driven by partially the multi-year medical cost / G&A savings noted at the 2018 Investor Day and continued improving performance across Optum. Our ‘19/’20/’21 est. are now $14.60 / $16.50 / $18.70 vs. previous $14.57 / $16.10 / $17.96 – generally in-line w/consensus. PT is now $276 off new 2020 EPS of $16.50 assuming a 10% premium to S&P multiple of ~15x / target relative multiple of 16.7x.
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On the Q4 earnings call UNH stressed the MLR miss in the quarter was almost entirely due to Medicaid performance. The co noted 2018 saw a pullback in TANF Medicaid performance in 5 states but wouldn’t talk to which states these are other than to say none of their peers are in all 5 and IA is clearly one of them. UNH remains focused on trying to move Medicaid business back to its target margin range 3% to 5% (more below) and also stated that performance in 2H improved vs. 1H but still not up to par. The co reiterated the MLR of 81.6% for FY18 and UHC operating earnings of $9.1B were in-line with the guidance laid out at November I-day. Additionally, UNH noted that commercial MLR trajectory through the year was steeper in 2018 vs. previous due to more high deductible products.
UNH reported 4Q’18 adj EPS of $3.28, above Wolfe/Cons $3.24/$3.21 as a strong top-line and lower than expected SG&A offset higher MLR / lower inv income in the qtr. Total rev of $58.4B (up 12.2% y/y, ~10.5% ex-HIF) was above Wolfe/Consensus of $58.1B/$58.0B w/SG&A of 15.1% for the year vs. guide of ~15.3% and MLR at 81.6% for the year vs. 2018 guide of ~81.5% at investor day. 2019 guidance reaffirmed at adjusted EPS of $14.40-$14.70 (Cons pre earnings was $14.62, implying ~13.5% growth off FY18 earnings of $12.88). We expect the focus for investors to be drivers of elevated MLR and read-thru’s for rest of MCOs with our view being UNH is likely seeing some impact from increasing seasonality as well as the typical white noise in MLR that ensues when medical cost trend is fairly stable rather than declining – which is the feedback we have gotten from NFP checks.
Earlier today (1/14/2019) CMS released the January enrollment data for Medicare Advantage providing the first look of how the fall 2018 Annual Enrollment Period played out and thus far it looks like growth is mixed across the group with AET (CVS) being a notable outperformer. While we note that January enrollment in general has become a bigger piece of annual growth (January was ~20% of total in 2015 growing to ~40% in 2018) a majority of the growth is still yet to come and the return of the Open Enrollment Period in 2019 (seniors can shift from plan to plan once during the first three months of 2019) may also impact enrollment #s unexpectedly. While co. specific growth is too early to call, the Jan enrollment paints a picture of large for-profit plans taking significant share again and the Feb growth report next month will bring co. specific and industry growth into greater clarity.
CVS’s recent commentary on rebate guarantees at a competitor conference forces questions for peers. As discussed in our note last night (1/8/19), CVS management has been the most vocal about the headwinds from lower branded drug price inflation to contracted rebate guarantees. Our industry checks indicate the practice has been wide-spread across the industry, begging questions around exposure at peers ESRX and OptumRx. As we discuss below we think the exposure at OptumRx should be much more moderate for a couple of reasons while ESRX is likely similar but potential offsets have left us more comfortable here while also acknowledging the topic as one of the main risks to our Outperform rating on post-deal CI.
This morning (01/07/19), CI filed an 8-K ahead of an investor conference and provided some color on membership growth in FY19. CI expects overall medical membership growth of 300K-400K with MSD growth in individual MA. This is approximately in-line w/ WR’s estimate of ~400K overall membership growth and 5% individual MA growth. In addition, the co. reiterated ESRX’s core adjusted script growth of 2%-3% in 2019. The co. is expected to provide full guidance for the combined co. on 4Q earnings scheduled for Feb. 1, 2019.
We are downgrading MOH to Peer Perform from Outperform primarily driven by two factors: (1) the company has more than met our expectations on margins and from here we expect shifting investor focus to top line growth and (2) we see a more compelling NT risk-reward in WCG at the moment. We note Management has done an incredible job of recovering margins well ahead of original goals with the company poised to earn 3.2% after-tax NI margin in 2018 compared to goal of 2.3%-2.7% in 2020 laid out in May investor day. While cost savings opportunities remain and we expect the company to help investors better understand their view of sustainable margins at the upcoming JPM conference next week, a combination of less relative visibility on top-line growth, lower likelihood of M&A post stock pullback / ACA uncertainty and a potentially more compelling NT opportunity elsewhere leads to a shift in our pecking order for 2019 but we whole-heartedly acknowledge the stock is cheap on forward #s, especially if mgmt. can deliver EPS growth in 2019.
We are upgrading WCG to Outperform from Peer Perform and raising our 2019 year-end PT to $263, implying 13% upside to Wednesday’s close. After years of admiring the company from afar due to valuation concerns, we advise investors take advantage of the recent pullback in the stock. The company should enjoy unique earnings growth visibility over a multi-year period as laid out further below. In addition, we see potential upside to #s in several areas including further capital deployment and optionality should WCG be awarded one large Medicaid contract management has acknowledged bidding on (NC ~$2B – 2/4/19 expected award) and/or one they are being less transparent regarding (TX ABD/TANF ~$1/$2B – summer/fall). Our #s move higher for 2020 EPS by ~6.5% to $15.95 from $15.00 to reflect AET PDP acquisition and Medicaid margin improvement. Our revised 2020 target of $263 (13% upside) reflects a 5% premium vs. S&P + discount of 2021 EPS acceleration.
We Remain Constructive on MCOs but See Risk/Reward More Balanced. MCOs have a strong fundamental backdrop and several tailwinds (HIF holiday / investment income) that support unique earnings visibility into 2019. That said, given current relative valuations appear to reflect much of this 2019 MCO earnings momentum we take a more measured view on the group as there are a number of potential factors that could weigh on sentiment and operating performance going into 2020. See PDF page 11 below for more details on these potential factors and please join our webcast this morning at 11am ET (click here to register) where we will discuss our views and answer questions.
We had the opportunity to host a day of investor meetings with WCG CFO Drew Asher & VP Beau Garverick. The tone of the meetings was constructive as the co. continues to feel “good” about the business despite recent stock-price pressure. As outlined in the recent 2019 guidance release, the co. expects organic growth in all three lines of businesses (Medicaid, MA, PDP) and sees a multi-year margin expansion opportunity on the $6B of new revenues primarily from Meridian, FL, and IL (more below). While the stock has been under pressure we continue to see the story as relatively intact and we will be hosting a webcast tomorrow at 10:30am ET to discuss key takeaways from the meetings. See our slides for the webcast in this note beginning on page 3.
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