Yesterday (11/17/2017) CMS released a regulation covering proposed policy and technical changes to Medicare, primarily related to Medicare Advantage and Part D. The proposed regulation is separate from the normal rate update process (proposal in February, final rule in April) and comes in response to the request for information (RFI) that CMS released earlier this year during the 2018 rate update process. Beyond technical changes to facilitate the implementation of the Comprehensive Addiction and Recovery Act (CARA) and the 21st Century Cures Act, the proposed regulation seeks to encourage innovative plan/benefit design and while somewhat uncertain would also appear to eliminate the Star Ratings benefit from contract consolidation in Med Adv. If finalized, these changes would become effective for the 2019 plan year.
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We had the opportunity to meet w/a broad swath of HUM mgmt. including CEO Bruce Broussard and CFO Brian Kane as well as segment operators. Despite all the discussion around vertical M&A and an increasingly competitive Medicare Advantage environment, the co. continues to see an ability to meet membership and earnings growth targets through a focus on driving differentiated clinical performance at the local level via increased focus on physician integration and greater use of home care delivery models. In terms of their own strategy around M&A / capital deployment, CEO Bruce Broussard noted the management & board will continue to focus on maximizing shareholder value (we didn’t come away with view that anything is imminent) while highlighting continued interest in broadening its delivery capabilities via partnership/acquisitions in both the home nursing and physician businesses. Overall we continue to see HUM as uniquely positioned to participate in the fast growing Medicare Advantage space but with important decisions to make over the next several quarters/years as their competitors continue to push forward both in terms of horizontal and vertical diversification.
While our 2017 EPS migrates slightly higher from $11.55 to $11.60, we are lowering our 2018 EPS estimate from $12.07 to $11.86 primarily due to more modest expected margin ramp in Humana’s key Medicare Advantage Retail segment. Our 2019/2020 EPS estimates remain unchanged. Recall on last week’s earnings call management provided early comments on 2018 EPS, noting that the high end of the EPS range will be a bit below its long-term growth target of 11-15%. Based on the adjusted EPS baseline of $11, we estimate an implied 2018 EPS range of $11.66-$11.99 vs consensus at the time of $12.28 (now $12.14). See our previous note here and Exhibit 1 on page 2 for more details. The company will provide full 2018 guidance on the Q4 earnings call and we note that initial guidance will assume a normalized rate of PYD in the Retail segment and no PYD in the Group and Specialty segment. In addition, we will be meeting with the company on Tuesday, Nov 14th in Louisville and will follow up with takeaways – don’t hesitate to reach out with questions for management or to set up a call to discuss afterwards.
This morning (11/9/2017) CMS released its first enrollment snapshot of the Open Enrollment season for states using the Healthcare.gov platform. Interestingly, CMS will now report enrollment on a weekly basis vs biweekly basis in previous years. As a result, this year’s initial enrollment snapshot covers only 4 days vs 12 days last year. Recall, open enrollment for the 2018 plan year was shortened to 6 weeks vs 12 weeks in previous years, which makes it particularly hard to draw meaningful y/y comparisons. Earlier this year, President Trump cut the ACA advertising budget from $100m to $10m and additional outreach funding from $63m to $37m, which coupled with concerns around enforcement of the individual mandate, caused some to fear that enrollment would be down sharply. However, absolute numbers have started out strong, which is certainly an encouraging sign for insurers remaining in the individual market (ANTM, CI, CNC, MOH).
On 10/31/17 it was reported that AmeriHealth Caritas (not public, not covered) was pulling out of Iowa’s recently launched Medicaid Managed Care program. ANTM and UNH are the other participants in the program and at the time it seemed likely that AmeriHealth’s membership would be split between the two remaining plans until the state could add 1 or more plans through an RFP. Instead, local news reported yesterday(11/8/2017) that all of AmeriHealth’s members would move to UNH unless they elected to move to ANTM. With recent rate increases provided to plans not sufficient to achieve actuarially sound rates, we expect the incremental enrollment / revenue is likely to be negative margin in the near-term but long-term positive and importantly we note that UNH is able to generate margin on incremental membership beyond insurance underwriting through Optum including Optum Rx.
On this morning’s call (11/08/17) HUM provided fairly detailed color on their expectations for 2018 guidance. Post 3Q17 EPS HUM reiterated that $11 remained the correct jump-off post for 2017 EPS post significant outperformance in 2017. From there, HUM said that it expects the high end of its guidance range will reflect a growth rate “a bit” below the 11-15% the company targets over the medium/long term. Assuming that “a bit” below = 2% (our guess) and guidance will reflect 9% growth at the high end, this would put the top of the guidance range at $11.99 vs. Wolfe/Consensus of $12.07/$12.28. We would note that ~$12 at the high end is not too far from our expectation as laid out previously and highlighted on Exhibit 2 on page 2. In addition HUM noted that it would provide a wider range than it did for 2017 ($0.20 or 2%), so assuming a 3% wide range would leave 2018 guidance at $11.66-$11.99. See Exhibit 1 on Page 2 for details. We are not surprised by the stock reaction (down ~4% at present) given investors were expecting the high end of range in-line with 11% growth (low end of 11-15% target) off $11 starting point in our view – vs. ANTM/UNH where expectations were more muted and thus being able to guide high end ~ in-line w/consensus was well received w/stocks up 4-5%). Looking ahead we think it’s important to note that HUM’s guidance reflects Individual Med Adv margins slightly below the company’s 4.5-5.0%, highlighting earnings power above where guidance will be provided for 2018.
HUM reported 3Q’17 adjusted EPS of $3.39, above Wolfe/Consensus of $3.24/$3.26 driven primarily by higher PYD / lower utilization in the Group segment and lower tax rate. Retails results were described as in line with HUM’s expectations while HC Services was slightly below. Total revenue of $13.3B versus Wolfe/Consensus $13.3/$13.4B. HUM increased 2017 adjusted EPS guidance from $11.50 to $11.60 reflecting the outperformance in the Group segment (+$0.20), partially offset by lower guidance for HC Services (-$0.11). Similar to peers, we expect stock reaction to be tied closely to 2018 commentary on the call including any updated on 2017 jump off point (previously $11), thoughts on Med Adv member growth, 2018 benefits of announced headcount reductions (2,700 employees) and any color around comfort w/current consensus ($12.28).
Cash EPS was $0.97 vs. WR/Consensus of $1.09/$1.08 with downside driven completely by DMG miss. Kidney Care results were in line with our model despite a ~$14M Hurricane headwind but DMG results were $44M below, with mgmt citing a ~$30M headwind from higher than expected patient acuity/costs and a ~$13M headwind from delay in finalizing PY Med Adv payments. The DMG results would be disappointing in any context but particularly so given CEO Kent Thiry’s 9/7/17 commentary at a competitor conference that DMG had “very nice” operating momentum across the board. The glass half full view here as noted in our recent upgrade is that it is possible for investors to win despite DMG futility should co. pursue a sale, and to that end CEO Thiry noted in prepared remarks “we are pursuing strategic alternatives for underperforming assets”. See more below on this topic. In addition on Kidney Care the company guided to flat Op Inc at the high end (which the co. has typically delivered) which we note is ~5% core growth ex the $100m retiree cost headwind in 2018 and it is that core growth that we are looking for again in 2019 to be another driver for the stock. All that said Q3 was highly frustrating and we expect the stock to react negatively tomorrow but the risk/reward remains compelling going into 2018 in our view. Forward #s largely intact with YE18 PT remaining $73 and reiterate Outperform rating.
THC reported 3Q17 EBITDA of $507M, in line with its pre-release. Hurricanes ($30M) and FL/TX Medicaid cuts ($10M) were a headwind vs. guidance provided with 2Q17 results of $500-$550M. Adjusting for these items, 3Q17 EBITDA would have been ~$547M, above both WR and Consensus, with the beat driven by strong cost management. THC lowered 2017 adjusted EBITDA guidance by $100M, reflecting: $60M headwind from hurricanes, $15M from lower TX/FL Waiver revenue, $17M from executive severance, and $8M due to “core” results (after offsets from cost reductions). This implies Q4’17 EBITDA of $796M vs. Wolfe/consensus of $836M/$831M respectively.
As with other Hospitals, CYH was negatively impacted by the challenging utilization environment in addition to weather related disruptions from hurricanes. While CYH completed its previously announced 30 hospital divestitures and continues to execute on its divest and deleverage strategy, we estimate core growth remained subdued in the quarter. We are reducing our estimates (more below) to reflect CYH’s revised guidance and to imbed more conservatism around its core growth going forward. Our YE18 Price Target decreases from $7 to $5 as we roll forward our estimates using a target EV/EBITDA-NCI multiple of 9.4x.
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