Centene: A Growth Healthcare Stock At A Bargain Value

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About: Centene Corporation (CNC), Includes: ANTM, HUM, MOH, UNH, WCG
by: Directional Capital
Summary

Centene is lagging behind its peers trading at 11x P/E 2020 vs. 15x for the sector's average.

The integration of WellCare does not seem to be correctly priced in, and synergies could lead to earnings surprises.

As uncertainties diminish, a re-rating and conservative EPS growth could yield a 27% annualized return for a 2.5-year holding period.

Centene Corporation (CNC) is one of the main healthcare companies in the US. It has been growing fast both organically and through acquisitions, and apparently its recent acquisition of WellCare (WCG) is not correctly priced in. The combined company trades at 11x P/E 2020 according to our estimates, compared to 15x for its peer group. Assuming reasonably conservative growth estimates the stock could yield a 27% annualized return for a 2.5-year holding period, which looks very attractive for a company of this size.

Figure 1: CNC's Price in the Last 5 Years

Source: Seeking Alpha

Centene is lagging behind the market due to uncertainties regarding the healthcare industry, as well as potential disrupting new entrants such as Haven (the joint effort by Jeff Bezos, Warren Buffet and Jamie Dimon to curb healthcare costs and improve its quality). This seems to put its stock in what we call a special situation: a potentially undervalued stock due to great concerns regarding its future earnings. That is why we like it as an investment in a well-diversified portfolio, as it could yield an asymmetric return in a relatively short period of time.

Figure 2: CNC's Valuation vs. Peers

Source: Seeking Alpha and Author

Why Centene Seems a Winner in its Industry?

Scale: Centene will manage approximately 23 million lives after it integrates WellCare. This gives it a huge amount of data that is crucial to improve the quality of service at the same time as it helps reducing costs, let alone the bargaining power to negotiate with suppliers and business partners.

Low Cost: Due to its focus on low-income brackets, Centene must be cost efficient in order to survive in such a complex industry. This gives it an advantage in our view specially in an industry so vital for people's wellbeing and highly scrutinized by ever-growing costs.

Technology: Cenete has a great focus on technology in order to improve its services and lower its costs. This is crucial in the healthcare industry and we believe it could help dramatically in increasing its efficiency over time.

Track Record: Centene has a very successful history of both organic growth and accretive acquisitions. Its recent acquisition of WellCare does not seem fairly priced yet, and we believe Centene has all the means to integrate this business and extract meaningful synergies. The company deserves the benefit of the doubt in our view regarding future growth expectations.

SWOT Analysis

Strengths: Scale, technology orientation, track record.

Weaknesses: Dependency on the Government.

Opportunities: Integration of WellCare, organic market share gains, digitization of operations, leveraging on its huge database.

Threats: Rising healthcare costs, Government budget's restrictions, disrupting new players.

Porter's Five Forces Analysis

Threat of New Entrants: The most threatening potential new entrant is Haven, the recently announced new company created by Amazon's Jeff Bezos, Berkshire's Warren Buffet and JP Morgan's Jamie Dimon. Here there seems to be a mid-to-high degree of risk to Centene's business.

Threat of Substitutes: There are different healthcare alternatives and different products and companies out there, but nothing that seems to change dramatically the market in the foreseeable future in this front.

Bargaining Power of Costumers: Individually each customer does not represent a threat, but the Government (federal and at the state-level) is powerful enough to have a huge bargaining power. The state of California accounted for 13% of total revenues in 2018 (vs. 21% in 2016) and the State of Texas 10% of revenues in 2018 (vs. 13% in 2016).

Bargaining Power of Suppliers: Centene has developed a large network of physicians, hospitals and other providers. We do not believe there is any relevant concentration among its providers.

Competitive Rivalry: Due to the complexity and inflationary nature of the business, there does not seem to be irrational competition in this industry thus far.

Investment's Pivotal Points

This are the key points for the investment in Centene to prove profitable in our view:

  • Federal and State Governments must keep the subsidies to Medicaid and Medicare.
  • Centene must successfully integrate WellCare and extract its synergies guidance of at least US$700 million.
  • Centene must be able to grow its top line organically at least close to 10% for the next 3 years (which is a quite conservative assumption), with a gradually-improving EBITDA margin.
  • The competitive environment should not deteriorate too much in the short-to-mid term.

There are many other aspects and risks to Cenete's investment thesis, but if the above-mentioned conditions are satisfied we believe there is a meaningful probability that Centene's multiple should re-rate towards the sector's average P/E of 15x. This coupled with a 13% EPS CAGR should lead to a 27% average annual return on the investment.

Conclusion

In our view, however, Centene looks well positioned to deliver low cost, good quality healthcare to low-income people as it focuses on scale gains and technology to drive costs lower and improve quality of service. It could represent a great alternative to ever-increasing healthcare costs and is a thousand miles ahead of potential new entrants in terms of data collection, expertise and infrastructure. With the stock trading close to 11x P/E 2020 at US$53/share, we believe the investment could yield a 27% annualized return for a two-and-a-half years holding period.

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.