You may not have heard of Centene Corp. (NYSE:CNC) even though it is in the S&P 500. The company does not get a lot of press or attention from the financial markets. It is not involved in the business of artificial intelligence, driverless cars or space travel and is not a volatile meme stock being discussed ad-nauseum on social media and CNBC.
Rather, Centene is a managed health care company. Don't say I didn't warn you; it is not an exciting company in an exciting business. However, it is a growing company with great valuation ratios and deserves a closer look.
What does Centene actually do?Centene is one of the leading providers of government-sponsored health care in the United States. Almost 80% of its revenues comes from Medicaid and Medicare. Medicaid is federal and state government-supported health insurance for low-income individuals. Medicare is federal government-supported health insurance for citizens over the age of 65 (as well as people with disabilities under the age of 65).
Here is how these segments have grown since when they were first reported in 2022.
Medicaid and Medicare have been struggling recently with low or negative revenue growth. This is concerning since these are by far the largest segments. However, the Commercial segment is growing rapidly and is flipping the overall revenue growth to positive.
Centene also provides cost data for these segments, which is really helpful. Below is a similar chart for gross income.
It is a similar story to revenue. The government-sponsored programs are seeing declines in gross income, but the Commercial segment is picking up the slack. Commercial actually generated almost 50% of the gross income in the first quarter of 2024. Compared to just 20% of the gross income in the first quarter of 2022, that is a significant increase.
It is important to note the growth for the total company (green line) is positive in each quarter except for fourth-quater 2023 gross income. So Commercial is doing some heavy lifting for the entire company. Let's look at each segment in more detail to find out what is going on.
Medicaid is dropping, but only for the short termCentene is the market leader in Medicaid, accounting for almost 20% of the market. This is almost double its closest competitor, Anthem (NYSE:ELV), which is now known as Elevance Health (NYSE:ELV).
As shown earlier, the Medicaid segment accounts for almost 65% of Centene's total revenue. The fact the segment is declining is very concerning, but digging behind these numbers shows it is not as bad as it appears.
As part of its response to the Covid-19 pandemic, the federal government allowed more individuals to sign up for Medicaid through their individual states. This led to a massive increase in the number of Medicaid members being serviced by Centene.
With the pandemic largely over, states are not receiving as much federal assistance for their Medicaid programs. This started in 2023 (hence the decline), but states are returning to normal operations at different rates.
This sounds really bad for Centene, but we need to look at the big picture. KFF is forecasting between an 8% and 28% drop in Medicaid participants as a result of this change. That is a wide range, so let's look at each scenario to see how those numbers look.
Worst-case scenario, Centene will lose 28% of its Medicaid members. That means its future membership would be around 11.50 million from the peak of almost 16 million in 2022. That is still a third higher than pre-pandemic levels. If we took the midpoint (18% decline), membership would be over 50% higher. The best-case scenario (8% decline) yields a value that is 70% higher.
In the short term, we should expect the membership numbers to decline, but that is the result of a policy change at the federal government level rather than a worrying trend. Over the next few years, we should expect Medicaid membership levels to decline, but start to stabilize and increase in the medium to long term.
Medicare is starting to show some cracks
The Medicare segment is also declining, but it is not as pronounced as Medicare, nor is it as significant of a segment to Centene. My immediate concern is the large drop in gross income.Historically, the gross margin for Medicare was in the low to mid-teens. However, the last two quarters saw a significant drop in the margin. What happened?
Remember, Medicare is for older Americans and they avoided medical visits because of the pandemic. When the Covid pandemic became less severe, Medicare participants started to use more medical care, which drove up costs.
This trend is concerning, but Medicare is a smaller part of Centene's business, so I am not too worried. Some competitors, like Humana (NYSE:NYSE:HUM) and UnitedHealth Group (NYSE:NYSE:UNH), have a much larger exposure to Medicare and will be impacted more by rising costs.
Commercial is driving recent growthMedicare is going to struggle for a bit and Medicaid is in a tough spot. So why do I think Centene is a good investment? Largely because of its growing Commercial segment, which is the company's insurance through the Affordable Care Act marketplace. Similar to the Medicaid segment, Centene is the market leader in this space.
Over the past 24 months, revenue in the Commercial segment has almost doubled and gross income has increased almost 150%. That is significant growth, but is it expected to continue?
This is where it gets interesting for Centene. Remember all of those people on Medicaid that are going to be removed after the pandemic? Those people are going to need to get insurance somewhere and many of them are going to be using the insurance through the ACA. Here is enrollment projections from the Congressional Budget Office:
Centene's diversity in the health care segment is really helping here. While Medicaid is going to struggle, Commercial is going to pick up the slack until it recovers.
What should we expect moving forward?Analysts are forecasting a small decline in operating income in 2024, but expect that to reverse to positive growth in 2025.
Probably even more importantly, earnings per share is forecasted to continue to grow even in 2024 and beyond.
Last December, company management issued guidance for diluted earnings of at least $6.70 per share (a slight increase from the 2023 fiscal year). However, when the company reported first-quarter earnings at the end of April, management increased the diluted earnings expectations to $6.80.
Valuation ratios look greatCentene is a great company and is executing on its mission. However, just because it is a great company does not mean it is a great investment. To determine if it is a good investment, we need to look at its valuation ratios.
The company's price-earnings ratio is near a 10-year low and suggests the stock is currently undervalued.
CNC Data by GuruFocus
Additionally, the price-book ratio is only 3% higher than its all-time low.
CNC Data by GuruFocus
Morningstar analysts use 14 times earnings to determine their price target. Using earnings per share of $6.80, which management is using as their minimum forecast for 2024, yields a price of $95. This is over 40% higher than current price levels and shows a buying opportunity.
Wall Street analysts also agree. Their average price target is a little lower at $$87.30, but that is still around 30% higher.
Even the most bearish analyst has a price target that is 14% higher than the current price.
Final thoughts: Centene checks all of the boxesThis chart sums up the reason investors should be excited about Centene.
The money spent on government-sponsored health care as a percentage of gross domestic product is expected to rise over the next few decades. This spending is expected to outpace other sectors of the economy and is an opportunity for companies that service this industry.
Centene is in a great spot to take advantage of this growth since it is one of the largest providers of government-sponsored health care. Throw in some great valuation ratios and it is no surprise that Centene has one of the highest GF Scores in the health insurance sector.
Centene is not going to make headlines or increase by 10 times in a year or two. It is, however, a market leader in a growing sector that should see above-average returns for the foreseeable future.
For long-term investors, this is the type of opportunity we are always looking for. If you don't have a position in Centene, now is a great time to start one.
This content was originally published on Gurufocus.com
