When we first wrote about Amerigroup (AGP) in December 2010, the company’s stock was trading at about $44 per share. Over the following seven months, the stock traded as high as $75. Then the axe fell. By the end of July 2011, the stock price swooned to a low of about $50 and then the market fell apart.
As of August 12, shares of AGP closed at $45.13. What happened to cause this radical and precipitous decline in such a short period of time? The first catalyst appears to be a warning issued by AGP concerning a report that the State of Georgia would audit Medicaid records. Amerigroup said that Georgia, in the course of its audit, discovered that it had made a number of duplicate payments to several insurers. Georgia would seek reimbursement from the insurers which resulted in a $0.16 per share charge to Amerigroup. This news caused AGP’s shares to drop 21 percent.
The next catalyst was Amerigroup’s Q2 report. The company’s results of $0.83 EPS were below the analyst consensus. In our December article, we noted that FY11 EPS estimates ranged from $3.60 to $4.12 with seventeen analysts forecasting a decrease in earnings over the prior year. Since EPS for the first half of the year came in at $2.20, it is difficult to understand the sell-off. Current estimates for FY11 range from $3.80 to $4.45 with a consensus of $4.09, down from a month ago consensus of $4.50.
Amerigroup is a multi-state healthcare company specializing in publically financed healthcare programs, including Medicaid, Children’s Health Insurance Program (CHIP), Medicaid expansion programs and Medicare Advantage. The company provides medical, social and behavioral health services. As of June 2011, the company serves nearly 2 million members in about twelve states.
In Q2 2011, revenues totaled $1,527.4 million, 6.3% more than the $1,437.5 million reported for Q2 2010. For the trailing twelve months, revenues are up 10.7% to $6,064.4 million from $5,476.0 million. As expected, EPS in Q2 2011 was down to $0.83 from the year-ago quarter of $1.31. However, for the trailing twelve months, EPS is $5.47 as compared to $3.35 though we note the quarterly trend is down. By our estimates, revenues are growing at the rate of 18.6% per year and free cash flow grows at about 8.5% per year.
On a more positive note, Amerigroup is retaining and expanding its presence in Texas. AGP is the largest Medicaid health plan provider in Texas, a state with population growth. Membership continues to expand and premium revenue continues to grow. Additionally, AGP’s board of directors authorized a $250 million increase to the company’s ongoing share repurchase program, bringing the total authorization to $650 million.
Some analysts are beginning to take notice of these positive developments. Carl McDonald, an analyst at Citi (C), issued a positive research note after the Texas contract announcement. Separately, Stifel Nicolas upgraded AGP to “BUY”, saying “investors are rethinking their views on Medicaid MCOs in the wake of AGP’s disappointing 2Q results…the earnings miss drove an overreaction in the shares relative to pending growth.”
Our readers were forewarned about cuts in publically financed healthcare reimbursement rates in our look at AGP in December. We may expect more rate cuts as the congressional and administration leadership in Washington re-divide our shrinking pie. Rate cuts notwithstanding, the number of people being covered by publically financed healthcare will inexorably expand, driving revenue growth. Efficient operators will be profitable.
Management at Amerigroup appears to be doing a credible job by winning new contracts and retaining expiring ones. As noted above, Citi analyst Carl McDonald has revised upwards his 2012 and 2013 projections for AGP. The company sells at low 8.3X earnings. It has an enterprise value to EBITDA ratio of 3.74; EV to Free Cash Flow ratio of 5.0X, and; EV to Sales ratio of 0.31.
The company provides a cash return on invested capital of 24.44%. AGP shows no long-term debt on its balance sheet but it does have $854.9 million in cash and short-term investments. The company also has tangible book value of $20.72. We think AGP could easily support a price of 10-11 times free cash flow; a discount to its five year and seven year averages of 14.1X and 15.6X, respectively.