As an independent licensee of the Blue Cross and Blue Shield Association, this well-managed company provides affiliated health and specialty insurance plans for government and commercial clients. While the shares are down year-to-date because of coronavirus fears, we believe that the current share price provides an opportunity for investors looking for discounted opportunities in the health insurance industry. While Anthem may see a negative earnings impact from the pandemic later in 2020, we believe that its long-term prospects remain solid given its scale, rising enrollments, and strong balance sheet. We also expect the impact of the virus to be offset by the company’s new in-house pharmacy benefit manager (PBM), IngenioRx, which launched in 2Q19. As such, with the stock now trading at just 10-times our 2021 EPS estimate, we view ANTM as undervalued. Our revised target price of $300, lowered from $310, implies a multiple of 12-times our 2021 EPS estimate, still below the peer average, and a potential gain, including the dividend, of 16% from current levels.
RECENT DEVELOPMENTS
Over the last three months, ANTM shares have underperformed the S&P 500, with a flat return compared to a 10% gain for the broad market. The shares have also underperformed over the past year, rising 9% compared to a 13% gain for the index. However, they have outperformed over the past five years, with a gain of 83% versus a 71% advance for the S=PSampHE=P 500. The beta on ANTM is 1.05, in line with the average for peers that include CI, HUM, and UNH. Anthem has taken steps to increase access to medical care for members during the pandemic; however, these steps may impact its 2020 financial results. Specifically, Anthem announced that it would waive copays, coinsurance, deductibles, and prior authorization for coronavirus tests. It also recommended that its members make use, when possible, of online services such as LiveHealth Online, which has made more physicians available to handle the potential influx of patients. It has also waived member cost sharing for telehealth visits, including for mental health services, waived cost sharing for COVID-19 treatment, and relaxed early prescription refill limits, when legally permissible, for members who wish to receive a 30-day supply of maintenance medications. The company has also created digital tools to provide information on the pandemic. These include C19 Explorer, which provides dashboards on infection rates and community risk scores to aid in reopening plans; C19 Navigator, which provides Anthem’s employer customers with clinical insights and predictions; and Biometric Passport, which allows employers to assess the safety of employees re-entering the workplace without compromising individuals’ health data privacy. It also includes tools for individuals such as Sydney Care, which provides real-time access to health information, telehealth services, and information on testing locations; ianacare, which allows users to co-ordinate practical help such as dropping off groceries and picking up medications; and PsychHub, which provides a range of mental health resources for people coping with pandemic-related stress. In addition, the portal includes access to Aunt Bertha, a social care network that helps connect individuals and families to more than 35,000 reduced-cost social service programs, such as food delivery, and help with paying bills. In addition, the Anthem Foundation has committed $50 million to aid COVID-19 response and recovery efforts in areas of greatest need. Management also announced that the foundation would match 200% of associate donations to certain charities that are helping to address the pandemic. Beyond its COVID-19 response, the foundation has also committed $50 million over the next five years to combat racial injustice, strengthen communities, and address health inequalities.
ANTM reported 2Q results on July 29 that topped analyst expectations for earnings but missed out on revenue. This was the company’s second consecutive quarter of better-than-expected earnings. The company posted second-quarter adjusted net income of $9.20 per share, up from $4.64 per share recorded in 2Q19. EPS topped the consensus by $0.62. On a GAAP basis, net income rose 104% to $8.91 per share. Total operating revenue rose 16% to $29.2 billion, but missed the consensus by $196 million. The increase was driven by pharmacy product revenue related to the launch of IngenioRX, higher premium revenue due to growth in Medicare and Medicaid, and the return of the health insurance tax in 2020, partially offset by a decrease in experience-rated premiums in the company’s Federal Health Products & Services business. Medical enrollment totaled 42.5 million members, up 4% year-over-year, while the benefit expense ratio fell 880 basis points to 77.9%, driven by the deferral of healthcare utilization due to the pandemic. Nonetheless, the companywide operating margin rose 580 basis points to 11.5%. Along with its 2Q results, management reiterated its guidance for adjusted 2020 EPS of more than $22.30. It also expects GAAP EPS of more than $20.91, down from its earlier estimate of more than $21.00. However, given pandemic-related uncertainties, Anthem did not provide other financial guidance for 2020.
EARNINGS & GROWTH ANALYSIS
Anthem provides health insurance for both government and commercial clients in the following customer groups: National Accounts, Local Groups, Individuals, Medicare Programs, Medicaid, Federal Employee Programs, BlueCard, and Specialty Products. The company has a track record of consistent growth. In 2Q, total revenue rose 15% to $29.3 billion, stemming primarily from operating revenue, with the remainder coming mainly from investment income. Premiums, which accounted for roughly 86% of operating revenue, rose 7% to $25.1 billion; product revenue, which consists of revenues from the newly created IngenioRx segment, accounted for 9%, or $2.5 billion; and administrative fees and other revenue, which accounted for the remaining 5%, rose 70 basis points to $1.5 billion. By segment, operating revenue grew 11% to $17.2 billion in the Government Business (59% of total operating revenue), but fell 7% to $8.8 billion in the Commercial & Specialty Business (30% of operating revenue). The operating margin rose 520 basis points in the Commercial & Specialty business to 15.6%, and 630 basis points in the Government segment to 9.4%. The operating margin for IngenioRx was 5.8%. We are raising our 2020 adjusted EPS estimate to $22.80 from $22.32, representing full-year earnings growth of 17%, based on the company’s ability to increase margins and our expectations for further strong contributions from IngenioRx (despite the impact of the COVID-19 pandemic). We are also raising our 2021 EPS estimate to $25.50 from $25.48, implying 12% growth next year.
FINANCIAL STRENGTH & DIVIDEND
Our financial strength rating on ANTM was raised from Medium Medium-High, the second-highest rank on our five-point scale. The company received above-average marks on our three main financial strength criteria: fixed-cost coverage, debt levels, and profitability. As of June 30, 2020, Anthem had cash and equivalents of $6.03 billion, up from $4.94 billion at the end of 2019. Total debt was $22.48 billion, up from $20.09 billion at the end of 2019, but accounted for 39% of total capital, down from 40% and below the peer average of 41%. We view average levels as 50%-55%. Operating income of $3.36 billion was up 135% and covered interest expense by a factor of 17, up from 8 in 2Q19; our view of an average interest coverage ratio is 10-12. The second-quarter adjusted profit margin was 8.1%, up from 4.8% in the prior-year period. Second-quarter operating cash flow of $5.51 billion was up 283%. Moody’s rates the company’s debt as Baa2/stable and S&P rates it as A/stable. Anthem has a share buyback program. It resumed buybacks in late June after suspending them in March due to the pandemic. During the second quarter, it repurchased $55 million worth of its stock. As of June 30, 2020, it had $3.2 billion remaining on its buyback authorization. The company pays a quarterly dividend. It raised the payout by 19% in late January 2020 to $0.95 per share, or $3.80 annually, for a yield of about 1.5%. Its last quarterly payment was on September 25 to holders on record as at September 9. Our dividend estimates are $3.80 for 2020 and $4.00 for 2021.
MANAGEMENT & RISKS
Gail K. Boudreaux has been the president and CEO of Anthem since November 2017. She previously served as the CEO of United Healthcare, a division of UnitedHealth Group, where she increased membership by more than 8 million members in six years. Elizabeth E. Tallett is Anthem’s Chair, and has been a member of the board since 2013. John E. Gallina is executive VP and CFO. He joined the company in 1994 and became CFO in June 2016. Investors in ANTM shares face risks. The company must accurately predict healthcare costs in order to set appropriate premiums. Its business could also be impacted by changes in funding for Medicare and Medicaid programs, and by other factors that could reduce enrollment. In addition, Anthem faces a range of regulatory, compliance, and legal risks, including ongoing lawsuits. As highlighted above, the company also faces risks related to the spread of COVID-19.
COMPANY DESCRIPTION
Based in Indianapolis, Anthem is one of the largest health insurance companies in the U.S. As an independent licensee of the Blue Cross and Blue Shield Association, the company serves members in California, Colorado, Connecticut, Georgia, Indiana, Kentucky, Maine, Missouri, Nevada, New Hampshire, New York, Ohio, Virginia, and Wisconsin, as well as specialty plan members in other states. ANTM shares are included in the S&P 500 Index.
VALUATION
At current prices near $260, ANTM shares are trading above the midpoint of their 52-week range of $171-$310. From a technical standpoint, the stock has advanced roughly 53% from its 52-week low of $171.03 in March 2020 and is currently up about 9% for the year. While ANTM has followed a long-term trend of gradually lower highs dating back to its all-time-high of $317.99 in February 2019, we believe that it currently offers significant upside. The stock faces resistance near $300 per share, roughly marking an extension of the line connecting its February 2019, July 2019, January 2020, and June 2020 highs. On the flipside, discounting the sharp declines in both the market and the stock in March 2020, the shares found support earlier this month at their 200-week moving average. Furthermore, with both the 14-day and 14-week relative strength index below 50, we believe that ANTM has more potential upside than downside in the near term. To value the stock on a fundamental basis, we use peer and historical multiple comparisons, as well as a discounted cash flow model. The shares are trading at 10-times our 2021 EPS estimate, below the five-year historical average of 14 and the industry average of 17. They are also trading at 0.6-times sales, compared to an industry average of 1.1. Despite concerns about the impact of the coronavirus, we believe that the company’s strong growth through the first half of the year, rising enrollments, new in-house PBM, and regular dividend hikes warrant a premium valuation. Our revised target price of $300, lowered from $310, implies a multiple of 12-times our 2021 EPS estimate, and a potential gain, including the dividend, of 16% from current levels.
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