Anthem Is A Strong Buy For The Long Term
Summary
- Anthem stands poised to benefit from an increased consumer base along with a projected increase in government healthcare spending.
- Past and present innovations suggest this company will be able to stay ahead of the curve in the long run.
- Both the relative and future cash flows models project a stock price that shows Anthem is currently undervalued.
- Strong financials but upcoming legal battle and potential repeal of ACA provide cause for concern.
Investment Thesis
After the share price dropped 50 points in the last month, right now presents a great entry point into Anthem (NYSE:ANTM). An increasing new consumer base along with financial models that suggest the stock is undervalued lead me to this position.
Introduction
Anthem Inc (ANTM) is a holding company that offers a plethora of healthcare plans to employers and individuals as well as medicare and medicaid markets which serve 40 million americans. The company offers an array of insurance products under its umbrella including managed care services, and dental, vision and life insurance that make it a potential one stop shop for insurance needs. Ranked 29th in the Fortune 500 as well as #4 among healthcare providers, Anthem can be considered an industry leader.
Expanding Consumer Base
The healthcare industry as a whole is expected to see an increase in their consumer base for 2019 and beyond. The expansion and improvement of government healthcare policies such as medicaid and medicare will help drive continued growth in this industry. For example starting this year the seniors enrolled in the Medicare Advantage plans (approximately 36%) will enjoy new and more flexible healthcare offerings. This helps healthcare providers because instead of the more relatively broad plans they would offer those enrolled in medicaid, now they can choose what type of benefits they are willing to offer. There are three segments in the new medicaid advantage plans: basic supplemental benefits, targeted supplemental benefits, and chronic care supplemental benefits. With one of the biggest market caps in the industry I'd expect Anthem to be a big player in all three segments as it is already a leader with medicare advantage plans. Although President Trump has mentioned the idea of cutting spending with medicare and medicaid, the amount of government spending is planning to increase from a projected $800 billion in 2019 to over $1.2 trillion in 2025. It also helps that the number of people eligible for medicare will rise by a projected 9 million people over the next six years. Increased government spending along with and increased amount of eligible seniors is great news for Anthem which relies on both to drive revenue growth.
Innovations
Among healthcare providers it can be hard to differentiate your company as many consumers and companies look for the best value when choosing a plan. Anthem however, is trying to change that with recent innovations that will help them try to differentiate from competitors in the future. They were an innovator when it came to shifting to a value-based care model back in 2012. Anthems next innovation revolves around battling the rising cost of prescription drugs which has a substantial effect on their bottom line. To battle these rising costs Anthem is implementing a new system called PBM (pharmacy benefits manager) which will help both patient and provider. Projected to be fully operational in 2020 this system is projected to save Anthem $4 billion is gross savings by using pharmacy data to reduce drug costs, identify gaps in care and improve medication outcomes. To help adapt their company to a smartphone centric world Anthem launched Engage in 2017. This is an app that allows those enrolled in an Anthem plan to access coverage information, find a care provider and pay your bill among other things. At the heart of this is providing those enrolled with connivence which has never been more important than it is today. It differs from competitors apps because Engage has very positive reviews unlike competitors such as Cigna, and allows those enrolled in medicare and medicaid to use its app unlike United Health Care.
Valuation & Financials
Anthem currently trades at a trailing 14.8x earnings which lags behind the industry average of 19x earnings. Twenty two analysts average projection for the 2019 EPS for Anthem to rise to 17.61. Using the relative model the best case scenario could see Anthem's P/E multiple reaching the industry average of 19x earnings which is certainly possible considering its place as an industry leader. This scenario would produce of stock price of 17.61eps x 19 P/E = $335 per share. A conservative estimate would see the P/E multiple rising to 17x earnings as concern over the ACA bill as well as litigation concerns with Cigna would keep Anthem's P/E multiple from reaching the industry average. In this scenario Anthem's stock price would be 17.61 x 17 P/E= $299 per share. In my opinion the conservative estimation is a very realistic price target for 2019, with the best case scenario not out of the question. The future cash flow model paints even more of an optimistic picture when projecting Anthem's stock price as seen below.
| Data Point | Source | Value |
|---|---|---|
| Valuation Model | 2 Stage Free Cash Flow to Equity | |
| Levered Free Cash Flow | Average of 13 Analyst Estimates (S&P Global) | See below |
| Discount Rate (Cost of Equity) | See below | 9.2% |
| Perpetual Growth Rate | 10-Year US Government Bond Rate | 3% |
An important part of a discounted cash flow is the discount rate, below we explain how it has been calculated.
| Data Point | Calculation/ Source | Result |
|---|---|---|
| Risk-Free Rate | 10-Year US Govt Bond Rate | 3% |
| Equity Risk Premium | S&P Global | 7.1% |
| Healthcare Unlevered Beta | Simply Wall St/ S&P Global | 0.72 |
| Re-levered Beta | = Unlevered beta (1 + (1- tax rate) (Debt/Equity)) = 0.718 (1 + (1- 21%) (30.56%)) | 0.891 |
| Levered Beta | Levered Beta limited to 0.8 to 2.0(practical range for a stable firm) | 0.89 |
| Discount Rate/ Cost of Equity | = Cost of Equity = Risk Free Rate + (Levered Beta * Equity Risk Premium) = 2.95% + (0.891 * 7.05%) | 9.23% |
Discounted Cash Flow Calculation for NYSE:ANTM using 2 Stage Free Cash Flow to Equity Model
The calculations below outline how an intrinsic value for Anthem is arrived at by discounting future cash flows to their present value using the 2 stage method. We use analyst's estimates of cash flows going forward 5 years for the 1st stage, the 2nd stage assumes the company grows at a stable rate into perpetuity.
| 2019 | 2020 | 2021 | 2022 | 2023 | |
| Levered FCF (USD, Millions) | 4,999.78 | 5,672.82 | 6,794.50 | 7,189.50 | 7,622.58 |
| Source | Analyst x5 | Analyst x5 | Analyst x3 | Analyst x2 | Est @ 6.02% |
| Present ValueDiscounted (@ 9.23%) | 4,577.21 | 4,754.43 | 5,213.22 | 5,050.06 | 4,901.73 |
| Present value of next 5 years cash flows | $24,496.64 |
| Calculation | Result | |
|---|---|---|
| Terminal Value | = FCF2023 × (1 + g) ÷ (Discount Rate – g) = $7,622.58 × (1 + 2.95%) ÷ (9.23% – 2.95%) | $124,916.48 |
| Present Value of Terminal Value | = Terminal Value ÷ (1 + r)5 = $124,916.48 ÷ (1 + 9.23%)5 | $80,328.05 |
| Calculation | Result | |
|---|---|---|
| Total Equity Value | = Present value of next 5 years cash flows + Terminal Value = $24,496.64 + $80,328.05 | $104,824.70 |
| Equity Value per Share(USD) | = Total value / Shares Outstanding = $104,824.70 / 258.64 | $405.29 |
| Calculation | Result | |
|---|---|---|
| Value per share (USD) | From above. | $405.29 |
| Current discount | Discount to share price of $248.42 = -1 x ($248.42 - $405.29) / $405.29 | 38.7% |
Source: SimplyWallSt
Anthem posses a clean balance sheet highlighted by its ability to cover short term commitments with cash & short term assets. This is important because this shows Anthem ample room to take on new enrollees without much short term risk. Analysts also predict revenues to increase from $91.64 billion in 2018 to 97.57 billion in 2019. A modest growth rate of 6.5% but should be enough to help keep the stock price rising. On the income statement net income was able to rise by 59% in 2017 compared to 2016 and while that is expected to be scaled back in 2018 I would expect net income to keep steadily increasing going forward. My biggest concern for the company's financials going forward is it's long term debt is expected to keep rising with its ongoing legal battle with Cigna over the failed merger. Not only will a costly legal battle increase debt but as highlighted in its 10-K report it may also have an adverse affect on its ability to keep spending on R&D. Now it is still very possible Anthem will win in court or may settle quickly avoiding a long and costly trial.
Conclusion
If you are buying Anthem stock at the moment you are getting a clearly undervalued stock in a continually growing industry. Anthem continues to be a leader in the healthcare industry and with a growing consumer base and new innovations make this stock a smart long term play.
This article was written by
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.