Cornell graduate David Einhorn is the highly successful value investor behind Greenlight Capital. The fund's annual return since inception (in 1996) has been around 20%, and Einhorn is receiving a boom in popularity from his renowned short of Green Mountain Coffee Roasters (GMCR). I have gone through Greenlight's 13F filings for the second quarter of 2012 and compared it to the filing for the previous quarter, trying to analyze what Einhorn bought in the last quarter and provide my personal opinion about each pick. Here are some highlights for the long side of his portfolio that I have noticed:
UnitedHealth Group (UNH)
I like the fact that UnitedHealth reported a strong quarter, beating estimates and giving an optimistic outlook. The company reported Q2 earnings of $1.27 per share, $0.08 better than the Capital IQ Consensus Estimate of $1.19, while revenues rose a strong 8.0% year/year to $27.27 billion vs. the $27.34 billion consensus. I think it is great to hear that management raised EPS guidance for FY12, forecasting EPS of $4.90-5.00 from prior guidance of $4.80-4.95 vs. $5.00 Capital IQ Consensus Estimate.
For the foreseeable future, I expect higher loss ratios to be offset by operating efficiency and growth of the services business. I like UNH because the company is well positioned in Medicare and Medicaid, with a national footprint, consumer focus, and a provider-friendly approach to managed care.
In reaction to the upholding of Obamacare, insurers will likely be viewed to benefit from the expansion of coverage and expiration of the risk that the individual mandate will be repealed. I think this is a strong thesis to invest in UNH and other managed care companies, as Einhorn did. Mark Adams from Warren-Trades newsletter explains which medical stocks will profit from the coming Medicare changes and UNH is one of his top recommended picks.
I think that shares are clearly undervalued. The shares of Humana currently trade at 9.5x consensus 2012 earnings estimate, a 29% discount to the 13.4x industry average. On a price-to-book basis, the shares trade at 1.4x, a 22.2% discount to the 1.8x industry average. The valuation on a price-to-book basis looks attractive, given the trailing 12-month ROE of 15.4%, which is way above the negative industry average. A high ROE multiple shows that management is executing well and generating shareholder value.
In the last earnings report, the company gave an outlook below market expectations. Humana reported Q2 earnings of $2.16 per share, while revenues rose 4.5% year/year to $9.70 billion vs. the $9.83 billion consensus. Management issued downside guidance for Q3, forecasting EPS of $2.00-2.10 vs. $2.59 Capital IQ Consensus Estimate. Management also issued downside guidance for FY12, projecting EPS of $6.90-7.10 vs. prior guidance of $7.38-7.58 and vs. $7.82 Capital IQ Consensus Estimate. I think that HUM is a buy opportunity despite the last earnings miss. In fact, management explained that the downside projections are not from downtrends in HUM's core operations:
"This reduction in FY12 EPS guidance primarily reflects higher-than-previously expected individual Medicare Advantage benefit ratios associated with new members and increased utilization for both new and existing members."
I believe that despite a lowered outlook, investors should buy during weakness in the shares of HUM. My opinion is based on the growing Medicare population, popularity of Medicare Advantage ((MA)), and Humana´s proven ability to manage within this complicated program. The MA program and its approach will likely be used as a solution to longer-term Medicare cost challenges. Gaps down in HUM share valuation caused by short-term mistakes should be bought seeking longer term gain.
Similar to Humana, WellPoint reported weak earnings numbers. WLP reported Q2 earnings of $2.04 per share, excluding non-recurring items, $0.03 worse than the Capital IQ Consensus Estimate of $2.07, while revenues rose 2.0% year/year to $15.17 billion vs. the $15.3 billion consensus. I do not like the fact that management lowered EPS guidance for FY12, forecasting EPS of $7.30-7.40 from prior guidance of at least $7.57, excluding non-recurring items, vs. $7.76 Capital IQ Consensus Estimate.
Despite the miss, I think WLP represents a compelling buy opportunity. The company marries a leading brand name with a national footprint and a lower cost structure that should deliver better results in the future. Adverse selection, losses in national accounts and a tough underwriting environment have been challenges but the company is aggressively cutting costs, making acquisitions, and buying back its own stock which has helped offset the difficult environment. I believe that WLP is relatively inexpensive at current levels. Shares currently trade at 7.1x consensus analyst 2012 earnings estimate, a 50% discount to the 14.2x industry average. On a price-to-book basis, the shares trade at 0.9x, a 44% discount to the 1.6x industry average. The valuation on a price-to-book basis looks attractive, given the trailing 12-month ROE of 10.4% that is significantly above the negative industry average.
Despite the low valuation opportunity, I would like to see a pickup in earnings growth and better enrollment momentum before buying.
I like Aetna´s strategy to generate incremental fee revenues by managing the infrastructure necessary for care organizations. To this effect, recently, Aetna announced an initiative with Carilion Clinic, the largest health care provider in Southwest Virginia. As a result of this initiative, Accountable Care Solutions business signed 9 contracts and 6 letters of intent, and the company has a robust and growing pipeline of additional opportunities. The company's collaborative efforts will help identify gaps in care and improve outcomes, while introducing collaborative payment models designed to improve healthcare quality. I think that AET could be a buy opportunity considering the company's current pipeline and expectations that the pace of announcements gain momentum in the coming quarters.
AET shares are deeply undervalued. I like to buy solid companies at compelling valuation levels. Aetna´s shares currently trade at 7.3x consensus analyst 2012 estimate, which is at a 43% discount to the industry average. On a price-to-book basis, the shares trade at 1.2x, which is a 33% discount to the industry average.
Other stocks Einhorn bought
I am wary of Cigna's changing business mix and the emerging long-term risks of health reform. Cigna bet big on the future of Medicare Advantage with the HealthSpring acquisition and now finds itself exposed to future government reimbursement pressure which could create pressure for shareholders. If the commercial health insurance market shifts to a focus on individuals rather than employers, Cigna could find its core business under attack from a multitude of regional competitors. Considering Cigna also has significant leverage and complex contingent liabilities, I find other managed-care organizations, particularly WLP, to be more appealing from a risk/reward perspective.
I think that VMED is a wise bet. Virgin Media has been under pressure for the past few months due to concern that the increased competitive environment will significantly impact fundamentals. I believe that VMED is well positioned to continue to take market share within its footprint. That, along with strong operating leverage, an improving balance sheet and continued share repurchases, should translate to an increasing trading multiple. VMED currently trades at 5.3x 2012 operating cash flow (at the low end of US peers) and at a 12% FCF yield (at the high end of its US peers). I think the shares could go to the mid $30´s level.