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.
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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.
LPNT reported 3Q adj EBITDA of $183M, slightly above WR/Consensus est. of $180M/$179M. Cash revenues of $1,557M were inline with. WR / Consensus $1,557M / $1,554M. SS adjusted admissions increased 0.7% and pricing 1.4%, with same store rev +2.1%. LPNT guidance was left unchanged.
Latest reports suggest Hurricane Florence is expected to make landfall in the Carolinas beginning this Friday (9/14/18) and continue on into the weekend. Based on current projections of the path, the center of the storm is expected to make landfall near the southern coast of North Carolina and veer into South Carolina (See Exhibit 2 on page 3). Currently Florence is a Category 4 Hurricane (130+ MPH Winds) with significant rainfall / storm surge expected. Overall relative to Hurricanes Harvey and Irma last year, our coverage composite has significantly less exposure to Hurricane Florence.
North Carolina released its Medicaid Managed Care RFP today (8/9/18) (RFP Summary and Draft Rate Book). The general structure of the RFP is similar to what we had originally outlined earlier this week in our webcast / slide deck on the NC opportunity, although there is some key new information (outlined below). For background on the RFP, North Carolina is planning a two-phase approach to a shift to Medicaid Managed Care with two enrollment periods (splitting regions) with Phase 1 scheduled to begin on November 1, 2019, and Phase 2 beginning on February 1, 2020. The current deadline to submit proposals is October 12th while the contract awards will be on February 4th, 2019. Populations targeted in the first wave of Medicaid transition include ABD, TANF, and maternity with exceptions including duals, medically needy, Pace beneficiaries, and others. Please see pages 2-11 for details from the RFP.
North Carolina is the largest state in the country that has yet to shift to Medicaid Managed Care. This will change soon, with the state pursuing a Medicaid 1115 waiver that would enable it to transition a significant % of spending to Managed Care over the next several years. Given the expected ~$12B revenue opportunity (~4% to total MCO Medicaid spend) we expect competition among plans will be intense. At the industry level, we estimate NC will contribute ~140bps to Medicaid MCO growth CAGR from 2020 through 2022. We expect RFP to drop in Sept/Oct (30-60 days after CMS approval) with implementation 18 months after waiver approval or early 2020. We will host a webcast at 11AM ET on Wednesday, August 8 to review our findings – an invite and reminders will follow. Slides can be found starting on Page 2.
Tonight (08/02/18) CMS released the Medicare FY2019 Hospital Inpatient Prospective Payment Systems (IPPS) final rule. Before accounting for Medicare/Medicaid Disproportionate Share (DSH) payments CMS estimates that industry rates will increase by 2.4% (vs. 2.1% proposed), with proprietary (for-profit) rates increasing by 2.1% (vs. 1.7% proposed). We also note that rates for Urban hospitals (+2.5%) fare better than Rural (+1.2%). Key drivers of the +2.4% include a market basket update of 2.9%, ACA cuts worth -0.75%, productivity cuts worth -0.8%, documentation and coding benefit of +0.5% and other small adjustments adding 50-60bps. Medicare DSH uncompensated care payments are in line with the proposal for FY2019 and should add an additional 130bps to rates. Including Medicare DSH, we would expect all-in reimbursement for the industry of +370bps and +340bps for the for-profits based on the final rule. This is modestly better than proposal and represents solid improvement over the FY18 rates (for-profits +230bps). We also note that Medicaid DSH cuts have been delayed until FY2020. We expect that core rates will continue to improve from here in 2020 despite ~30bps of expected pressure from Medicaid DSH cuts given that ACA cuts (-75bps) end after 2019. Importantly, our analysis of DSH changes indicates that HCA (+47%, +$219M) and UHS (+28%, +$20M) appear set to see larger increases with LPNT (+13%, $7M), THC (+7%, +$16M) and CYH (+7%, +$12M) below average increases.
Following Q2’18 earnings for most of our hospital coverage, we are updating #s and PTs for CYH, LPNT, and UHS (please also see our work on HCA post Q2 results including increased #s and PT as well as our “Blue Sky” scenario for 2019 earnings power – “Blue Sky” takes into account higher Medicare rates / DSH with the CMS final rule expected out later this week). We also get more conservative on UHS 2H’18 behavioral estimates which flow thru to lower 2019/2020 as laid out below. Overall hospital results have been generally in-line ex HCA’s strength. THC is last to report next Monday where results will likely take a back-seat to update on potential Conifer sale and further cost-cutting from management.
LPNT reported 2Q adj EBITDA of $187M, in-line with our estimate and 1% above Consensus of $185M. Cash revenues were $1,570M vs. WR / Consensus $1,597M / $1,585M driven by weak same store revenue, offset by better than expected margins. SS adjusted admissions increased 0.5%, with same store rev +0.6% (+0.8% ex asset transfer). LPNT narrowed 2018 EBITDA guidance range to $730M-$760M (from $725-$765M) and lowered revenue guidance by $105M to $6.25B-$6.32B (from $6.35B-$6.43B), with the sale of 3 LA hospitals now assumed effective 8/1/18. LPNT raised adjusted EPS guidance to $4.50-$4.93 from $4.00-$4.53. LPNT lowered SS rev growth guidance by 100bps to 0.5%-1.6% (from 1.4%-2.7%).
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