A funny thing happened to the health insurers in 2020, providing a case for healthcare stocks to buy.
They are making money.
You might think that COVID-19 would be ravaging the group. But when people lose their jobs, they lose their coverage. The pandemic also has many insured patients putting off elective surgeries that cost insurers money.
Stocks in these companies, however, haven’t been advancing with their profits. Analysts are pounding the table for them, but investors are saying “no, thanks.” We see the risks. Both political parties see healthcare as a major issue. Their proposed solutions could rattle the cage of all these companies.
How will they fare if Obamacare is declared unconstitutional? What about the Democrats’ proposal to offer Medicare to everyone?
While there’s certainty in the sector’s income statements, there’s uncertainty in the outlook. But if you make the right call on that future you can make fat profits.
- Centene (NYSE:CNC)
- CVS Health (NYSE:CVS)
- United Healthcare (NYSE:UNH)
- Humana (NYSE:HUM)
- Cigna (NYSE:CI)
Healthcare Stocks to Buy: Centene
Centene is my personal favorite in this group of healthcare stocks to buy. It seems to be the health care stock most threatened by today’s politics.
It may actually be the least threatened. By making a profit on Medicare and Medicaid contracts, Centene has transformed healthcare in a way that goes beyond politics.
The secret sauce of Centene is no secret. It’s called managed care. Non-profits like Kaiser Permanente have been all about managed care for years. Long-time Centene CEO Michael Neidorff simply brought the model to the for-profit market.
Under managed care, costs are controlled by owning clinics and other facilities that deliver it. Managed care also focuses on prevention, on keeping patients well and keeping them out of the hospital. About 75% of America’s medical bills come from “chronic conditions,” preventable diseases like diabetes and heart disease.
By staying on top of patients with regular check-ups and careful monitoring of medications, Centene keeps high-risk people out of the hospital. This lets Centene make a small profit on Medicare and Medicaid contracts, despite constant political pressure to cut those costs. This is a business its rivals don’t touch, except for “Medigap” plans that enhance Medicare.
For the second quarter of 2020 Centene earned $1.2 billion, $2.05 per fully diluted share, on revenue of $27.7 billion. Revenues were up 50%, and profits up 250% from a year earlier. This was thanks to its acquisition of Wellcare, a $17 billion deal that closed in January.
While rivals were losing customers during the pandemic, Centene added 1.1 million of them. Its model lets it consistently price policies on Healthcare.gov for less than rivals and deliver more care.
The fact Centene being an Obamacare winner is why investors have been dumping the shares. Investors believe the law will be declared unconstitutional and Centene will lose that business. Even if it isn’t, many believe Democrats will replace Medicare with a government-run plan.
Both sides of the argument are wrong. Managed care delivers better care for less than conventional insurance. If the exchanges are closed, Centene will find other ways to get that business. The Biden health care plan, meanwhile, doesn’t call for people to only be offered a state-run Medicare. It suggests consumers be able to buy into Medicare. The easiest way to do that would be through Centene.
I like Centene for the same reason many analysts now like Tesla (NASDAQ:TSLA). By linking the income of payments to the outgo of clinics, they have built a better health care mousetrap. Managed care works, politics be damned.
If Joe Biden wins in November, CVS is one of the best healthcare stocks to buy.
I have long believed no company is better positioned for the transition to managed care than CVS Health. Its drug stores and clinics provide low-cost distribution. Its Aetna insurance unit brings it guaranteed income.
But even efforts to eliminate Obamacare shouldn’t kill CVS. CVS can offer lower-cost primary care for the uninsured, using nurses, physicians’ assistants, and technology. The patent medicines and supplements that are a replacement for primary care with the uninsured are all available at your local CVS.
Under CEO Larry Merlo, CVS has been redesigned around the Affordable Care Act. Its Caremark pharmacy benefit manager assures it the best prices on drugs. Its network of over 9,900 stores give it wide distribution and customer convenience. It has bought several specialty pharmacies, putting them under its ProCare brand. It has a network of 1,100 MinuteClinics offering front-line care.
The most transformative deal was its 2018 purchase of Aetna for $69 billion. This assured CVS cash flow. For the second quarter of 2020, this meant revenues of over $65 billion, on which it earned nearly $3 billion, $2.64 per share. For the first six months of the year, top-line growth was 5.6%, with profits rising 48%.
Yet the stock hasn’t moved. Its valuation on Sept. 21 was still $74 billion, just over one quarter’s revenues.
CVS is only part-way through its managed care journey. It can control costs when people are well, for drugs and front-line care. What’s lacking are specialty facilities to give it visibility on costs when people get sick.
Instead of buying CVS, investors have been grabbing its primary competitor, United Healthcare.
UNH stock is up 41% over the last year, while CVS is down. The reason is UNH’s margins, 10.7% for the most recent quarter, nearly double that of CVS. Investors are buying UNH over CVS even though CVS’ dividend yield is twice that of UNH, whose $1.25/share payout recently yielded 1.62%.
UNH lacks CVS’ retail network, but it controls the AARP’s highly-profitable Medicare Part D business. UNH has also gotten into managed care in California, after buying a network of clinics there over several years.
United Healthcare didn’t want Obamacare. The company has extensive ties to conservative organizations and encouraged employees to lobby against the bill. But on March 10, 2010, the date when Obamacare was signed, was a great opportunity to get into United Healthcare.
At the time the shares were trading at about $32 each and paid no dividend. Their performance during the debate over the law trailed that of the S&P 500 by 2-1. Since then United Healthcare is up 815%, more than four times the gain in the S&P average.
UNH used stimulus money to automate operations. It gained control over drug prices after buying the Catamaran pharmacy benefit manager. It has been getting into managed care in limited markets.
United Healthcare today is the dominant pure play health insurer. It had $249 billion in revenue in 2019, against $104 billion for Humana, the second-largest pure play in the field. CVS and Cigna achieved similar scale to UNH only through mergers. CVS bought Aetna in 2018, Cigna bought Express Scripts in 2019.
Chances are, UNH will adapt well no matter the political environment.
Humana shares are up 9.5% for the year, about double the S&P 500’s 2.75% gain. Shares opened for trade Sept. 23 at about $388.
Of healthcare stocks to buy, Humana still looks like a bargain with a price to earnings ratio around 15x.
Analysts at Goldman Sachs (NYSE:GS) have an easy explanation for what’s happening.
Rising unemployment means fewer people are insured. The pandemic means fewer people are going in for elective procedures. Political concerns seem to have been put off until 2021.
Humana is looking for even bigger things in 2021. It has added Raquel Bono, former CEO of the Defense Health Agency, to its board of directors. The company sees care for both the military and veterans being privatized by the Trump Administration. These huge contracts could add billions to the Humana bottom line.
Humana began life as a Health Maintenance Organization, offering what passed in the 1990s for managed care. It now offers standard insurance and handles government contracts. About 16.7 million people get their health care through Humana. Investors Business Daily believes it now has the pricing power to take profits higher.
In addition to its big contracts, Humana is also a player in the Medicare Advantage business. Over 24 million people now buy these policies, but market penetration is still just 36%. This means more growth is available. Humana’s share is 18%, second only to United Healthcare’s 26%.
To grow that, Humana is launching new programs for older patients getting heart bypasses and shoulder replacements. This is in addition to existing programs covering new knees, new hips, and spinal fusions. The programs offer better care and lower prices at a network of participating hospitals.
Last up on this list of healthcare stocks to buy is Cigna. Cigna has re-branded its health services line, including the ExpressScripts pharmacy benefit manager it bought last year, as Evernorth.
Investors have yet to respond. Cigna shares remain where they were a year ago and there’s no dividend to speak of. Analysts say Cigna is undervalued.
After what was seen as a stellar second quarter report, analysts began pounding the table for Cigna. Cigna earned $1.8 billion, $4.73 per share, in the quarter ending in June, on revenue of $39.3 billion. Much of the revenue came from Express Scripts.
Cigna tried to gain scale through a 2015 merger with rival Anthem (NASDAQ:ANTM) but antitrust officials blocked the deal. The resulting lawsuits were only cleared in August with no damages awarded on either side.
Aetna, which had sought a merger with Humana, finally achieved financial scale by being acquired by CVS Health. Cigna has tried to get the same scale by spending $54 billion on Express Scripts. Express Scripts needed the merger after United Healthcare bought rival Catamaran for $12.8 billion, moving its own prescription business to it.
The result is Evernorth, which also includes Cigna’s specialty pharmacy, Accredo, and computer services for both customers and their employees. Tim Wentworth, who had been running Express Scripts, will run the new unit.
While United Healthcare has walked away from the marketplaces created by the Affordable Care Act, Cigna has gone into more of them for 2021. That sounds great, except the Trump Administration is trying to declare the act unconstitutional. In Georgia, the Republican Governor has sought a waiver denying Georgians access to the marketplace.
Without access to the Affordable Care Act markets, it’s hard to see where Cigna’s growth is coming from. Pharmacy benefit managers like Express Scripts are being tied closely to insurers, which is why Express Scripts took Cigna’s offer.
The Bottom Line
Analysts continue to pound the table for the health insurers, and investors continue to resist them.
There is more than political uncertainty at work. Health insurers depend heavily on big employers for their revenue. Some of the biggest are now going it alone. Berkshire Hathaway (NYSE:BRK.A), Amazon.com (NASDAQ:AMZN) and JPMorgan Chase (NYSE:JPM) have launched Haven Health to cover their million employees.
Will health insurance in 2022 look anything like it does today? What will today’s companies look like in the new environment? Personally, I think managed care will triumph, because it matches income with outgo and can be done profitably. But make your own call on healthcare stocks to buy.
Dana Blankenhorn has been a financial and technology journalist since 1978. His latest book is Technology’s Big Bang: Yesterday, Today and Tomorrow with Moore’s Law, essays on technology available at the Amazon Kindle store. Write him at firstname.lastname@example.org or follow him on Twitter at @danablankenhorn. As of this writing he owned shares in AMZN.