The Value in Trends (VIT) system uses a quantitative approach to screen for value. Then, the trend direction, momentum and condition is analyzed to determine investment entry/exit points. The VIT system produces an efficient overview of the fundamentals and technicals of a company, paving the way for further extensive research into economic conditions, industry dynamics and company specifics.
In their Q1 FY14 results, Magellan Health (NASDAQ:MGLN) reported a 17.6% increase in revenues to $966.5 million from $821.8 million a year earlier. Meanwhile, net income declined 8.9% to $25.7 million, equating to an EPS figure of $0.92. This was 22% higher than the consensus estimate of $0.75.
Since this announcement on April 29, analysts have downgraded their earnings but upgraded their revenue estimates. Adjusted net income of $67.8 million and $80.3 million are expected off sales of $3.72 billion and $4.42 billion in FY2014 and FY2015, respectively. That equates to EPS figures of $2.40 in 2014 and $2.84 in 2015, some 37% lower than the 2013 EPS figure of $4.53.
With the share price trading at $62.24 at the end of June, the FY15 EPS estimate has the company trading on a forward P/E of 22.9x. That's not particularly cheap but across other multiples, the valuation looks more attractive. FY15 Price/Sales is only 0.39x, while Price/Cash Flow and Price/Book are only 7.31x and 1.31x, respectively.
QUANTITATIVE VALUE ANALYSIS
I define value as the combination of an attractive price and quality factors. With regards to price, I look at a range of relative price multiples. Quality is broken down into profitability, health and efficiency analysis.
To examine price, I use the conventional approach of analyzing price multiples. I rank these into deciles with one being the cheapest 10% and 10 indicating the most expensive 10% of companies based on that specific multiple. Then, I backtest the performance of each of these deciles going back over the past 14 years (end December 1999 to end December 2013) to determine whether the company is attractively positioned based on the historical returns. I conducted my tests across the Russell 3,000 index.
- EV/EBITDA of 5.4 ranks in the first decile across the Russell 3,000. Companies in this decile have produced the highest active annualised returns, 15.1% p/a.
- The Company is ranked in the second decile in terms of P/E, with a reading of 12.4. Historically, this has been the second best performing decile, with a return of 10.3%.
- The P/S of 0.5x is undemanding and positions the group in the 1st decile. It has also been the best performing decile with returns of 19.3%.
- Magellan Health ranks in the third decile of P/B, with a reading of 1.2x. This has been the third best performing decile over the 14 years of data tested, with a return of 10.0% p/a.
- With a P/CF ratio of 7.5x, the company is ranked in the third decile, where companies have produced an annualised return of 10.1%. This has been the third best performing decile.
For quality purposes, I first analyze profitability and break down the calculation of Return on Equity through DuPont analysis. The resulting figure for Asset Turnover then measures efficiency while the reading for Leverage is an indication of health. Combined with profit margins, this gives a good overview of company quality. Once again, I rank the components into deciles from 1-10. Then, I backtest the performance of each of these deciles on the Russell 3,000 going back over the past 14 years to determine whether the company is attractively positioned based on the historical returns.
- ROE of 11.1% puts it in the fifth decile. Companies in this bracket were actually the third worst performing over the past 14 years, producing an annualised return of 6.6%.
- With a low profit margin of only 2.7%, the Company is ranked in the seventh decile. However, companies in this decile have produced active annualised returns of 9.6% over the period tested. That's good enough to be the second best performing decile.
- AT is impressive at 2.2x. This ranks it the top decile across the Russell 3,000, which has also been the best performing over the 14 years, producing an annualised return of 11.2%.
- The leverage reading is low at 1.5x. That ranks them amongst the lowest 30% across the Russell 3,000. However, this decile has actually been the third worst performing over the period tested, producing annualised returns of 5.8%.
TECHNICAL TREND ANALYSIS
I break down the examination of a company's trend into three components:
- Direction of the trend
- Momentum of the trend and;
- Condition of the trend
- Magellan Health's share price tends to be quite volatile. Nevertheless, it has risen almost 55% since 8th June 2012. The uptrend remains in place today, currently trading at $62.24. This price is above each of the 50-, 100- and 200-week moving averages. Therefore support levels exist at $59.15, $55.34 and $51.96, respectively.
- Momentum, as measured by MACD, did decline into negative territory in early April of this year. This coincided with the price testing the support of the 100-week MA. Since then, momentum has once again moved into positive territory with the share price rising almost 16% since the latter half of April. The trend in momentum is still up and far from extreme levels.
- The key levels to look out for on the RSI chart are 70 and above, which equates to an overbought condition. Meanwhile, a reading of 30 or below reflects an oversold condition. The last time Magellan Health's share price reached an overbought condition on the weekly chart was the week ending 20th July, 2012. Within a couple of weeks, the share price endured a 17% correction in a single week. Today, like many other instances in the past couple of years, with a reading of 62, the condition of the trend is nearing overbought. However, it is not actually overbought.
Based on the Value in Trends analysis, Magellan Health is an attractive proposition. Measured on relative price multiples, the company is in the top 30% cheapest across the Russell 3,000 index. In terms of EV/EBITDA and Price/Sales, the company is among the cheapest 10%.
From a technical perspective, the share price continues to advance with little evidence of immediate resistance. Momentum has picked up also and the stock is not yet in an overbought condition. However, the share price has extended considerably above the 100-week MA. Therefore, a correction toward the $52-55 handle would not come as a major surprise.
Taking all of the above into consideration, I believe existing investors should stay long Magellan Health, but initiate a stop loss just below the 200-week MA at $52. For those looking to initiate a position, my personal opinion is that a better entry price will emerge, providing an opportunity to buy into this opportunity.
Disclosure: I am/we are long MGLN.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.