Yesterday (01/16/19) HCA received regulatory approval from the North Carolina Attorney General for the acquisition of Mission Health. According to the agreement with the NC AG HCA will commit to provide services at local hospitals for at least 10 years, build new N.C. facilities, and support community service programs sponsored by Mission. The company also agrees to be subject to legal actions from the AG’s office should it break its commitments. We note that the Federal Trade Commission still needs to give approval for the deal to consummate. Mission expects the deal to close Jan. 31. We note this date may or may not have contemplated the continued government shutdown.
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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.
DaVita provided 2019 OI guidance of $1.54B - $1.64B, bracketing current Consensus of $1.627B and WR of $1.637B. OI compares to 2018 run-rate of $1.575B as we have previously published – growth of ~1% at midpoint and ~4% at high end which is what DVA typically delivers (see Exhibit 1 on page 2 for actual/guide historically). No update on DMG deal other than still working on Q1’19 close although gov’t shutdown does not help and expect to use significant majority of proceeds and future FCF for share repo while still considering possible M&A in the form of small/ancillary acquisitions. Overall the guidance was fairly inline with our expectations and feel free to email us for a copy of the slides.
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.
While not unexpected given recent focus here from investors, Friday’s ruling is certainly unfortunate given potential for angst (even if we think it is very low probability) into likely Supreme Court decision in early-to-mid 2020 coupled with recent market volatility heightening stock moves such as JNJ 10% selloff on Friday. In this note we attempt to lay out and quantify where possible, various ACA related impacts to both MCOs and Hospitals to better understand the potential moving parts here should the ACA be struck down. In short we think it is very unlikely the Supreme Court votes this down on third try given 5 Justices remain who have voted to uphold 2 previous times in last 6 years - as we lay out in attached slides and will discuss on webcast at revised time of 8:30am ET. Thinking about stocks across the sector we see diversified MCOs best positioned, hospitals potentially less negatively impacted than investors might expect and CNC/MOH most negatively exposed.
Today (11/28/18) the California Department of Managed Health Care (DMHC) announced the approval of Optum’s acquisition of Davita Health Plan of California (see news release here). The Health Plan is a subsidiary of Davita Medical Holdings which UNH will be acquiring as part of the DMG acquisition. The approval comes with several conditions, including Optum and DVA agreeing not to increase premiums as a result of acquisition costs and keep premium rate increases to a minimum. Optum and DVA also agree to invest at least $58 million in CA on philanthropic and educational initiatives. See the full list of DMHC’s conditions here.
We are adjusting our ests for 2018 operating income to reflect revised guidance of $1.5-$1.525B (see Q3 note for details). Our 2019/2020 est. adjust slightly, with ~8% total OI growth in 2019 and ~4.5% in 2020. EPS goes to $4.76/$5.96 in 2019/2020 (assumes DMG close now at end of Q1’19) vs. post-Q3 cons $4.74/$5.24.
We had the opportunity to host investor meetings with HCA incoming CEO Sam Hazen, CFO Bill Rutherford and IR Mark Kimbrough. With the recent quarter just reported and very few debates on the stock at present given recent strong performance, the meetings were focused on background around the 2019 outlook, business updates and capital deployment. We came away increasingly confident in the company’s strong business momentum heading into 2019 driven by continued growth in demand, share gains via significant in-flight capital coming online and a strong pricing and mix environment including growth in commercial volumes and favorable Medicare rates. We update our model w/2019 and 2020 EBITDA est. moving to $9.49B/$10.03B and our revised 2019 YE PT now $155 (~9.5% upside) vs. previous 2018 YE PT of $136 – and note this assumes a more conservative multiple of 9.0x EV/EBITDA-NCI vs. current 9.4x – see Exhibit 1 on Page 3 for more details on our PT buildup.
Look for DVA stock to be somewhat weak tomorrow after strong performance today on the combination of a confusing qtr. and uninspiring commentary on timing of DMG close – while disappointing we would be buyers on material weakness as core thesis remains intact. Operating Income of $314M in qtr compared unfavorably to Wolfe $358M and Cons of $364M. However to the $314M, we add back $23M for one-time retiree equity compensation (not contemplated in Cons/prior guide) and we assume $10M of the $20M increase in advocacy spend was in Q3. So $314M+$23M+10M=$347M – missing our # by about $10M which came in the ancillary/corp biz rather than core dialysis. Importantly given core operating income run-rate intact (more below) we see this as more of a timing issue. We will look to sort through EPS moving parts (tax rate/lower shares/higher int. exp) when updating model more fully.
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