Speculating With WellCare Health Plans

Jan. 9.12 | About: WellCare Health (WCG)

Healthcare was one of the best performing sectors in 2011. I wrote several articles describing what I saw as opportunities within this sector and paid particular attention to the health insurers. My articles covered companies such as Amerigroup (AGP), up 44%; Humana (HUM), up 62%; Aetna (AET), up 37%; and, Metropolitan Health Networks (MDF), a primary care network of healthcare providers, up 70% on the year.

When discussing the healthcare sector, the elephant in the room is the perceived impact of healthcare reform; both the expansion of services to the currently uninsured and potential cuts to Medicare and Medicaid. These prospects created a great deal of uncertainty in the markets. The Supreme Court has yet to rule on the healthcare reform law passed by Congress, and even if its constitutionality is upheld by the Court, we can expect opponents of the law to attack individual provisions of the law. Additionally, the yawning budget gap will require Congress to address the Medicare and Medicaid entitlement programs. With all this uncertainty, why have these companies seen been rewarded by the market? In our opinion, there are several reasons.

One reason is that both short term and long term demographic changes favor the industry. The short term benefit will be the estimated 32 million new insurance enrollees created by the reforms. Long term, aging baby boomers will swell the ranks of Medicare Advantage programs. Another reason healthcare companies have advanced in an otherwise dismal market is that they are adjusting their business models to benefits from these societal changes. The top five insurers have completed at least 10 deals to add Medicare Advantage enrollees or Medicaid enrollees to their list of customers. Though reimbursement rates may drop, the insurers can make up the difference with volume. If the insurers are able to continue to grow their profit margins, these companies will continue to do well. The most efficient providers will greatly benefit from this industry contraction.

WellCare Health Plans (NYSE:WCG) is one of the smaller (by sales) players in this industry. With revenues of $5,862.2 million, WellCare is far smaller than industry leader UnitedHealth (NYSE:UNH) with revenues of $9, 9976.0 million. Unlike the other companies mention here, WellCare’s fundamentals have been erratic and far less predictable. For this reason, we consider WellCare to be a speculative buy. Click to enlargeWellCare provides managed care services targeted to Medicaid and Medicare. It serves approximately 2.4 million people nationwide. Several years ago, the company was charged by Federal and state prosecutors with conspiracy to defraud two health care benefit programs. These charges were resolved when the company entered into a Deferred Prosecution Agreement with the U.S. Attorney and the Florida Attorney General.

Overall, membership increased year over year as of September 30, 2011 when compared with September 30, 2010.

Program

September 2011

September 2010

Change (%)

Medicaid

1,313,000

1,328,000

-1.1%

Medicare

2,410,000

2,200,000

9.5%

Total

3,723,000

3,528,000

5.5%

Click to enlarge

For the quarter ending September 2011, revenues grew to $1,544.4 million from 2010’s revenues of $1,388.2 million. For the twelve month period ending September, revenues declined to $5,862.2 million from $7,064.8 million. The company reported EPS for 3Q11 at $2.03 compared to $1.00 in 3Q10. EPS TTM grew to $4.75 from a loss of ($1.48).

As we said earlier, operating results have been erratic over the years. The company reported losses in FY 10 and FY 08.Operating income has ranged from a loss of $53.2 million to a high of $466.5 million for the last twelve months. Operating margins have averaged 2.36% for the last five years and net margins have averaged 1.26%. The company’s cash position is good with $1,787.7 million in cash and short term investments and $250.7 million in long term debt.

Analysts see 2011 as being a good year for WellCare but they also forecast a 26% decline in EPS for 2012. Analyst expectations are colored by the perceived effects of the aforementioned regulatory changes. Herein lies the challenge is valuing the company. Though analysts foresee a significant drop in EPS for 2012, their 3-5 year growth estimate is about 14.5%. WellCare looks cheap at 9.7X 2011 earnings and TEV/EBITDA of 2.4X. Past growth rates are not impressive. The company is throwing off a goodly amount of free cash, and by my estimate, the Cash Return on Invested Capital is about 44.8%. As the company is currently profitable, ROE is an impressive 22.5%. The stock price is also showing momentum so there are people who think WellCare has a ways to go yet.

The market seems to think WellCare will perform well in 2012. I am not convinced, and would consider WellCare to be a speculative play. There are better places to put your money in the health insurer industry.

Disclosure: I am long AET, AGP HUM, MDF