February 7, 2022 | 9:25 AM by CY | cy@jaguaranalytics.com

Anthem (ANTM): Singing a Defensive Tune

Large-cap pharma and managed healthcare have been relatively defensive places to hide out in this environment. These companies are near-duration cash cows, their valuations are lower than the S&P 500 average, and their businesses are somewhat immune to economic cycles. Without a doubt, these stocks are low beta and tend not to return more than 20% annually from a common stock perspective. But with VIX hovering in the 20s and 30s (and VVIX above 120) plus elevated uncertainty over the monetary policy outlook, now is clearly not the time for thematic traders with medium-term time horizons to be playing hero with other more volatile factors/sectors.

In terms of the aforementioned relative outperformance, we first picked up on the managed healthcare trend on December 7th, when UnitedHealth (UNH) was discussed in Conversations (see HERE). More recently, on February 3rd, we also flagged the possibility of a breakout in Regeneron Pharmaceuticals (REGN) (see HERE). Fahad has also discussed the healthcare space in general on multiple occasions in the chatroom in recent weeks. Now, we’re formally adding Anthem (ANTM) to the bullish list.

Anthem overview

Anthem, formerly known as WellPoint, probably needs no introduction for American Jags. Like UnitedHealth, they are one of the largest health insurance and pharmacy benefits companies in the country. They offer just about every managed health benefit plan under the sun, to large and small businesses, individuals, plus the Medicaid and Medicare markets. For readers who are unfamiliar, the diagram below (taken from HERE) neatly summarizes how the US private health insurance market works.

Apart from insurance plans, Anthem also provides a wide range of health-related administrative services to customers who are self-funded. This includes: claims processing, underwriting, actuarial services, provider network access, medical cost management, disease management, analytics, and wellness programs. Additionally, the company offers its own unique array of specialty management services in dental, vision, disability, kidney care, and radiology. And finally, the company provides services to the federal government in connection with the Federal Employee Program, and operates as a licensee of the Blue Cross and Blue Shield Association. If Anthem’s website images are to be believed, their services result in happy, satisfied, smiling Americans of all ages and walks of life:

As of December 31st, 2021, Anthem serves ~45.4M medical members (+2.4M YoY) through its affiliated health plans. The company grew revenue by 14.2% YoY to $36.0B, with inflows from premiums and products up 13.5% and 21.6%, respectively.

By the end of 2022, management expects memberships to come in between 45.6M to 46.2M, with EPS to be “greater than $28.25” (vs $24.73 in 2021). The benefit expense ratio is also expected to improve to 88.0% from 89.5% as of 4Q21, on cost reductions and a more favorable contribution from non-COVID-related care. Looking further out, management’s goal is to increase EPS by an industry-leading 12% to 15% annually through 2025, inclusive of share buybacks. Over the same period, government business revenue is expected to compound between HSD to LDD, supported by Affordable Care Act expansions, Medicaid and Blues Alliance partnership growth, and increased adoption of Anthem’s digital platform. Meanwhile, commercial and specialty revenue is expected to compound between MSD to HSD, on assumption that the company continues to enjoy similar bid levels to the last five years in national accounts and maintains its ~80% win rate on employers switching insurance carriers.

According to latest Street estimates, analysts currently expect Anthem’s EPS growth to average just 8.5% over the next two years, representing a sizable dislocation from management’s aforementioned goal of 12% to 15%. For the following reasons, I believe it is highly likely we will be seeing upward revisions from sell-side over the coming months.


Favorable CMS 2023 rate increase proposal

Just last week, on February 3rd, the US Centers for Medicare & Medicaid Services (CMS) published its proposed payment policy changes for Medicare Advantage and Part D drug programs in 2023. The most important part of the press release was the proposed 8% increase in private Medicare plans and roughly 5% for Medicare Advantage plans.

Analyst takeaways regarding the proposal were resoundingly positive:

  • Citigroup Healthcare analyst Jason Cassorla noted that the rate increases were markedly better than his own expectations, and represents a sign of support from the Biden administration:

“Heading into the 2023 MA Rate Notice, there was concern that the 2023 rate notice update would be more modest given the positive rate update of 4.1% in 2022 and this being the Biden Administration’s first-rate notice. With that, today’s rate notice should assuage those concerns with a strong 4.48% all-in rate update which does not yet factor in rebasing/re-pricing. For 2023, CMS is including an assumed adjustment for underlying risk score trend of 3.5%, which would lead to an overall assumed rate increase of 7.98%CMS is expected to issue its final 2023 MA rate update by Monday, April 4th, 2022. We note the final rate has tended to be revised upwards from the Advance Notice as comments are solicited.

  • Credit Suisse Health Equipment & Services analyst AJ Rice wrote that the all-in rate proposal does not yet factor in rebasing/re-pricing, and the implied overall assumed rate increase amounts to ~8%. Moreover, he observes that there is a likelihood for the final rate to be revised upwards on or before April 4th:

“Heading into the 2023 MA Rate Notice, there was concern that the 2023 rate notice update would be more modest given the positive rate update of 4.1% in 2022 and this being the Biden Administration’s first-rate notice. With that, today’s rate notice should assuage those concerns with a strong 4.48% all-in rate update which does not yet factor in rebasing/re-pricing. For 2023, CMS is including an assumed adjustment for underlying risk score trend of 3.5%, which would lead to an overall assumed rate increase of 7.98%CMS is expected to issue its final 2023 MA rate update by Monday, April 4th, 2022. We note the final rate has tended to be revised upwards from the Advance Notice as comments are solicited.

  • Similar to Citi, both Oppenheimer and BMO Capital would also conclude that the rate increase was above expectations and helps to alleviate some political concerns, with the former declaring: “The increase is well above expectations, which reflected broad concerns around the Biden administration’s posture on MA.”


Earnings and forward-looking commentary

On January 26th, Anthem reported the following key metrics for 4Q21:

    • EPS: $5.14 ex-items vs consensus $5.11 and year-ago $2.19
    • Operating revenue: $36.58B vs consensus $36.50B and year-ago $31.82B
    • Ending medical memberships: 37M vs consensus 45.28M and year-ago 42.93M
    • Benefit expense ratio: 5%, in line with consensus and vs year-ago 88.9%
    • FY22 EPS guidance: Greater than $28.25 vs consensus $28.59
    • FY22 Operating revenue guidance: ~$152.0B vs consensus $153.0B
    • FY22 Medical memberships: 45.6M to 46.2M vs consensus 46.8M

Notably, the company also enjoyed a 100% RFP win rate in 2021, including the crucial contract renewals in Tennessee and Indiana, plus a new win in Ohio.

Following the earnings call, JPMorgan Managed Care analyst Lisa Gill would argue that the earnings and membership guidance provided by management was too conservative and does not bake in the possibility of a public health emergency (PHE) extension nor any decrease in COVID testing and diagnostic costs:

“Management highlighted two important dynamics driving the shift vs normal seasonality: elevated COVID-related inpatient admissions primarily impacting the Commercial business and higher COVID testing and diagnostic costs that don’t count against members’ deductibles.

We expect COVID costs will decline into 2Q22 although the MLR benefit will be partially offset by the launch of the City of New York Group MA contract. We also expect another strong year in Individual MA with ANTM pointing to mid-teens membership growth. Medicaid redeterminations are expected to resume around mid-year although we would not be surprised if the PHE was extended again, potentially resulting in some upside to 2022 membership/revenue estimates.

We are raising our 2022 adj. EPS estimate to $28.40 from $28.30, although we continue to believe our estimate could prove conservative.

Meanwhile, RBC Capital’s Ben Hendrix states that reading between the lines, the initial FY22 EPS guidance implies that management foresees “no headwinds from excess member churn which drove an MA guide-down at Humana (HUM) earlier this month”, and that, The guidance reflects recapture of ANTM’s share of lost Medicaid volume on the commercial side through both employer ASO and IFP plans.

Truist analyst David MacDonald also believes the initial guide carries conservatism, arguing that the anticipated mid-2022 headwinds from redeterminations are already well understood:

“We remain bullish on ANTM and see reasons for optimism across the company’s diversified business lines. Attractive expected growth in Commercial, robust MA trends (Individual and sizable City of NY Group contract), and an impressive Medicaid win rate (with a couple of solid Medicaid tuck-ins) suggest encouraging core trends across the book.

In addition, while redeterminations are expected to resume mid-year, we view the topic as well understood, and see an opportunity for membership capture in other products and expect benefits from 2021 acquisition activity. Management introduced 2022 adjusted EPS guidance that was in line with our expectations (greater than $28.25 vs. our $28.30E) which we think carries an upward bias. In addition, ANTM delivered the best national account selling season in company history, and we see meaningful opportunity for continued integration and penetration of the ANTM book.”


IngenioRx and digital transformation

Another important bull case for Anthem comes from management’s ongoing digital transformation initiative, which began with the launch of network-based pharmacy benefits management platform IngenioRx in late 2017, coinciding with the termination of a long-time partnership with Cigna’s (CI) Express Scripts PBM. Aside from opening up new growth avenues and reducing operating costs, the ultimate goal of the platform is to speed-up and simplify the pharmacy benefits process by automatically matching the best overall health outcomes with the lowest possible total cost of care.


Since inception, IngenioRx’s revenue contribution has seen rapid growth, from zero in 2018 to $25.4B in 2021 (or $928M in operating profits), as Anthem continues to cross-sell the platform’s solutions to its national and Blue Cross/Shield accounts.
During the most recent investor presentation, management stated that they expect the top-line figure to compound at a LDD rate annually through 2025.

 

In the 4Q21 earnings conference call, Anthem CEO Gail Boudreaux would also say that IngenioRx has seen a strong start to 2022, and she sees potential for expansion into home care:

IngenioRx saw significant growth in net new sales to start 2022, keeping us on track with our goal of narrowing the profitability gap of risk-based and fee-based Commercial customers… As we’ve talked about for the last several quarters, the importance of social drivers of health and how much is occurring in the home, so that’s one area that we are very interested in. This also plays a critical role in terms of specialty pharmacy and potentially home infusion.”

In the same note referenced in the previous section, Truist would provide their own bullish thoughts:

“At IngenioRx, 2022 is off to a good start, with significant growth in net new sales. The company remains on track to narrow the profitability gap between risk-based and fee-based customers, and we continue to see opportunity with ongoing integration into whole health solutions alongside investment in additional offerings (e.g., specialty pharmacy, home infusion). We think the maturation of Ingenio has been key as clients increasingly look to consolidate with a single carrier, and we view Ingenio as well positioned for continued success. ANTM is seeing meaningful progress with the ongoing digital transformation, including a +150% increase in digital registrations during peak onboarding period.”

Strangely, no other sell-side firm makes a mention of IngenioRx in their takeaways, which is perhaps a sign that the cross-selling and cost-improvement bull case is going underappreciated by the Street.


Political risks? Yes, but we’re traders.

Admittedly, one major risk to health insurance companies is increased regulation. After all, government budgets are responsible for a large proportion of transactions within the industry. As things stand, the House Democrats and a handful of progressive Senators have consistently expressed their desire to pass legislation that would reduce drug producers’ ability to raise prices, and to fortify Medicare’s position when it comes to negotiating for lower prices.

However, we have to remember that the current makeup of the Senate, which is a perfect split of progressive Democrats vs Republicans plus moderate Democrats who are against sweeping rule changes, makes it highly unlikely that any major healthcare reforms will pass (or even be discussed meaningfully) during the next several months. Moreover, the significant lobbying carried out by the healthcare industry in Washington means that any eventual measures that do get passed will likely be a milder version of the House’s proposals.

In any case, our 3-to-4-month time horizon for this thematic trade idea coincides with that split Senate, which makes politics more of a tail risk rather than an immediate one for us. Nevertheless, it would be best to refrain from being too overweight the healthcare sector for this very reason (just have one or two open positions at most in the trading account).

 

Sweeping measures aside, one issue that does directly affect Anthem is a piece of news which emerged last week on February 3rd, regarding California Governor Newsom’s “behind closed doors” deal to give Kaiser Permanente a special 5-year Medicaid contract to expand its reach in the state and continue selecting the enrollees it wants, effective from 2024.

Reportedly, this secret deal has “infuriated executives of other managed-care insurance plans in Medi-Cal (including Anthem’s), who say they stand to lose hundreds of thousands of patients and millions of dollars a year”, and it “leaves them with a disproportionate share of the program’s sickest and costliest patients.”

Following the news, Wells Fargo analyst Stephen Baxter would note that Anthem, Molina Healthcare and Centene have significant exposure to Medi-Cal, while CVS and UnitedHealth have a very minor presence.” Specifically, Baxter estimated 1% earnings exposure for Anthem, 6% for Centene, and 5% for Molina. Thus, a tangible headwind, but not thesis-changing in our view.


Technical Picture and Trade Setup

 

 

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