I first wrote about Health Net (HNT) last August after doing research which led me to the conclusion that the stock had a considerable EPS ramp coming this year. I continue to stand by that view, but I think the elements of the story have changed some. Last year, I felt the growth in dual-entitlement eligible individuals in Health Net's coverage footprint represented a significant profit opportunity. And longer term, they do. This is a population that the market seems to be watching carefully as a measure of HNT's growth prospects. But while I think Duals represent a real long-term growth driver, in the short-term though, I am more excited about the expansion of Medicaid in California and its benefits for HNT.
The Medicaid expansion has flown under the radar to some degree, yet it appears to me that it could be a strong profit driver going forward. HNT recently released earnings and while those earnings came in a bit lower than analysts expected on a core basis (~$0.25 vs. expectations of $0.29, though the comparability of the two numbers was questionable in my view with analysts not including some costs that HNT did), I think the medium and longer-term opportunity in the stock remains. Health Net is in a major growth phase right now with firm management projecting 30% revenue growth in 2014 and at least $3 of EPS for the year. These kinds of statements from management give me added confidence that the best is yet to come for the stock.
What's more HNT management said that they expect that roughly ~600,000 new members will enroll in the programs by the end of 2014. While the company's SG&A expenses were higher than I would have hoped given past guidance, management said that this was due to greater expenses in preparing for the beginning of coverage under Obamacare and the California Care Initiative. To the extent that the firm can invest more now and then see better EPS growth later on, I am perfectly OK with that. HNT earned $2.21 in 2013, so if they can get to $3 a share in 2014, that will be outstanding.
Health Net is a relatively small insurer and consistent with that, they are heavily focused on the California market (which accounts for ~90% of non-TRICARE health plan enrollee's). In particular, the growth in Medicaid in California could be worth as much as $500 a month per enrollee to HNT in 2014, which would add substantially to the firm's earnings this year (perhaps $0.25 a share for the year). For comparison, Dual members are perhaps worth $2,100 per enrollee per month, so the much more numerous Medicaid population has a lot of value for the firm. The growth in dual enrollments though is a slower process, and I see it as a bigger driver of 2015 EPS than 2014 EPS (adding perhaps $0.60 a share to EPS in 2015 vs. only $0.05 a share in 2014). My point here is that while Duals are an exciting long-term opportunity, I think the Medicaid expansion is a more important growth driver this year. Anyone who reads the news even somewhat closely is no doubt aware that Medicaid enrollment rates have skyrocketed under Obamacare's loosened rules, and regardless of one's feelings about the program as a whole, it is clear that this is a benefit to selective insurers, among them HNT.
In that vein, it was not surprising that CMS reported a 5% increase in annual Medicare Advantage enrollments in January, which included an additional increase for HNT specifically of ~8,000 members (bringing the total to ~251,000 MA members for HNT). This is consistent with the firm's growth targets going forward.
It's worth adding a note of caution on my otherwise bullish view regarding Health Net. On the whole, this is a tricky time to be investing in all health insurers including HNT. While new plan members will certainly give an enormous boost to revenues going forward, additional taxes, and the sicker character of the new group will also drive up expenses. I believe, and most sell-side analysts seem to agree, that the increase in revenues will be bigger than the increase in costs. Some of the large insurers have said they think there is a good chance they will lose money on the Obamacare exchanges this year.
While Health Net has not said anything similar regarding its new members, I do worry about that a bit. In the end though, I think over the next 6-12 months, the firm will learn how to keep costs in line on the new group in line. My point here is not that Health Net is not a great company or that they aren't going to make a bunch of money based on these industry changes. In fact, I think they will make a pile of money here. But the road is likely to be rocky from here, and simply looking at enrollment numbers and revenues is probably going to be deceptive. Adding to this difficult is the significant volatility in HNT (and really all insurers') earnings in any given quarter. For example, as I already mentioned, HNT earned $0.25 on a GAAP basis last quarter. In the year ago period for that quarter the firm earned $0.36 (4Q2012), and in the 4Q2011 period the company earned $0.95. It's not that HNT's earnings have collapsed over time - they haven't. In fact in 3Q2013, the company earned $0.83 vs. $0.38 in 3Q2012. Insurance earnings are just volatile. What should matter to investors here is the broader trend and the bigger picture. Are earnings rising over time, and what is management guiding towards for the future? By those measures, Health Net is doing very well, and the future looks quite bright indeed. With the company trading in the low $30's, I think it remains a very solid long-term investment.