We’ve hosted management roadshows for CVS, CI, HUM and MOH over the past couple of weeks and not surprisingly coronavirus risk was one of the first topics that came up in every meeting. While the MCOs could not quantify the potential impact of COVID-19, all referenced an impact from a typical or severe flu as the most reasonable framework at this point. Overall, if the virus indeed spreads more widely, the companies generally expect the impact to be similar to a severe flu season where elevated medical costs have been generally manageable. However, the MCOs noted that there are certain tail outcomes that could potentially drive large increases in hospitalization / costs especially if the virus affects the broader population in a fairly severe form – see our CVS, CI, HUM, MOH mgmt meeting takeaway notes for more detail on discussions.
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CNC’s updated 2020 guidance includes a $0.17 drag from potential rate decrease in NY Medicaid programs. Per co. this assumes a $200M pre-tax hit before $50M of available offsets. As highlighted in our note from last night, ~$100M of the pre-tax headwind is due to the loss of bonus from an annual quality incentive program that would get suspended under NY’s proposal leaving $100M from the actual rate cut. Given CNC generates about ~$11B-$12B in premiums and serves about 1.56M members here, we estimate the actual NY Medicaid net rate cut was closer to 1%. Based on state reports, other MCOs in our coverage have more modest exposure to NY Medicaid relative to CNC w/ UNH having about 457k lives, ANTM 363k, and MOH 73k incl. 46k from pending acquisition of Yourcare Assets. Assuming a 1% margin hit due to the net rate reduction + loss of bonus which probably varies by plans’ ranking (more next bullet) + plans can offset 25% of impact, we est. the proposed rate cut would result in $0.03/$0.11/$0.06 of headwinds to 2020 EPS for UNH/ANTM/MOH respectively or 0.2%/0.5%/0.5% of our ests – see Exhibit 1 on Page 2. Finally to be clear the rate is not finalized yet as plans will likely lobby hard against the cut and may get some relief. CNC expects rates to be finalized by end of March and notes the rate reduction and estimated impact assumes any rate cut is retroactive to 1/1/20.
Fourteen states and one territory, 34% of total or 1,357 delegate counts on a combined basis, held nominating contests for the Democratic Party's candidate for president on Tuesday. While CA / ME, which account for 415 / 24 delegate counts, appear to be too close to project at this point, Biden won the primaries in Virginia, North Carolina, Alabama, Tennessee, Oklahoma, Arkansas, Minnesota, Massachusetts and Texas and Sanders came out on top in Colorado, Utah and Vermont. Based on the latest projection by the Associated Press, Biden’s is now leading the Dem primary election w/ 453 delegate counts vs. Sander’s 382. While it appears that the most likely outcome remains that no candidate will have a majority of delegates going into the Dem convention, a brokered convention appears to be highly favorable for Biden over Sander, materially increasing Biden’s odds of ultimately winning the nomination – discussed more below. As we highlighted in our previous notes, we were estimating the group can outperform the S&P500 by ~10% from here with a clearer path to a moderate Nominee over Sanders and looking at early trading today MCOs are going to get much of this in the near-term.
Post SC primary 3 Dem candidates Steyer, Buttigieg, and Klobuchar have dropped out of the race as Moderate Dems work to block Sanders nomination into Super Tuesday. It appears both former South Bend mayor and current MN senator are planning to endorse Biden at his rally in Dallas, TX tonight. Based on the latest RCP national polling aggregate from 02/20 to 03/01, which has only incorporated 1 poll conducted after Biden’s victory in SC over the weekend (out of 5 used in the aggregate calc.), these 3 dropouts would leave a total of 16.5% (Buttigieg 9.8% + Klobuchar 4.4% + Steyer 2.3%) of votes up for grabs. In terms of Super Tuesday states, latest RCP state polls show Sanders is leading in the 2 largest states by delegates – CA and TX which have 416 / 228 delegates or 31% / 17% of total contested tomorrow – w/ a 14.7% lead vs. Biden in the former and a 4.5% lead in the latter.
Biden won the SC primary by a much larger than expected margin of nearly 30% (vs. 15% seen in RCP polls on Sat) w/ 48.4% of total votes followed by Sanders at 19.9%, and Steyer at 11.3%. Incorporating SC results, 538’s primary model continues to forecast a brokered convention (more below) as the most likely outcome at 59% chance (+7% vs. pre-SC) while Sanders’ odds declined to 27% (-5%) and Biden’s declined to 14% (-2%). Given 34% of delegates up for grabs in 16 contests on Super Tuesday, we think the results here will go a long way toward indicating whether there is a viable path for any of the top candidates to win a majority of votes OR whether Dems are looking at a Convention battle in July. From a stock perspective, Biden’s win in SC is clearly favorable for MCOs but we expect the next major move in the group is more likely to occur post Super Tuesday.
Specifically we met with CFO Eva Boratto and EVP Alan Lotvin who now heads up the PBM business but previously was in charge of Transformation as well as IR Valerie Haertel and Katherine Durant. The discussion centered on the company’s Integrated Value initiatives including HealthHUBs as well as 2019 performance at HCB and initiatives for growth there. Overall, the company sees itself as well positioned to deliver both on 2020 earnings targets and fundamental change in healthcare delivery at the local level.
W/ 96% of NV precincts having reported already, Sanders has won the NV caucuses by a wide margin w/ 46.8% of total county convention delegates won followed by Biden at 20.4% and Buttigieg at 13.9%. This win continues Sanders momentum post IA / NH and has made him the clear front-runner for the Democratic nomination heading into SC on February 29 and Super Tuesday on March 3.
As we attempt to again put together the pieces of CVS financial disclosure and guidance (see our previous attempts at 2019 guidance and I-Day disclosure here and here) the two main questions at present appear to be: (1) what drove significant underperformance vs. initial guidance at the historical Aetna business (HCB) and (2) what are the offsets to significant improvement expected at the PBM (PSS) not to mention lower tax rate / interest expense that should have led to $0.50 of upside to prior $7+ expectation rather than ~$0.10. We attempt to answer those questions below but look for continued focus on these areas as CVS mgmt. meets with investors during Q1 including our upcoming meetings w/CFO Eva Boratto and other members of mgmt. later this week – see our questions for mgmt. on slides 10 and 17.
CVS reported Q4 adj EPS of $1.73 above WR/Cons of $1.68 and above the high end of 4Q range of $1.62-$1.70, primary driven by slightly better PBM and RLS results vs. our est. as well as lower interest expense / tax rate. PYD benefit for the quarter was 5c. MLR was 85.7% for Q4 and 84.2% for the full year, in-line w/ our est. for the quarter and co. guide of “above the mid-point” of 83.5%-84.5%. Total op profit of ~$3.77B was ~0.7%/0.8% above WR/Cons of ~$3.73B/$3.74B. FY20 EPS guidance of $7.04-$7.17 (vs. WR/Cons at $7.15 – incl. PYD of 10c) implies 3-5% growth from the 2019 baseline of $6.83 which excludes ~$0.25 of PYD/capital gain, higher vs. the prior LSD% growth guidance given at the I-day. Vs. our model this is primarily driven by higher PBM / higher synergy / lower interest expense partially offset by lower profit at Aetna business. Overall we think the quarter/guide will be well received but look for commentary on PBM outperformance and slightly lower expectations at AET vs. investor day.
As expected Sanders wins the NH primary with Buttigieg/Klobuchar close behind. Based on Sanders’ narrow margin of victory (<4%) 538’s model forecasts he has 48% chance of winning the majority of delegates followed by None (27%) and Biden (15%). With the field still rather spread out and Bloomberg gaining mindshare into Super Tuesday, it is increasingly possible that there is no clear winner going into the Democratic Convention in July and we expect investors to focus on this potential outcome – see convention rules here. Given results in-line with expectations we expect focus to shift to polling changes heading into NV on 02/22 and SC on 02/29 and from here we see MCOs still pricing in approximately 50/50 odds of Sanders getting the nomination vs. a more moderate candidate. See Exhibits 1 and 2 on pages 2 and 3 for current MCO group multiple and our view of sector multiple shifts depending on election outcomes.