Following Tuesday’s (4/17/2018) earnings report and conference call, we are revising our 2018 estimates upwards to reflect the Q1 beat and increased 2018 guidance. For 2018, UNH increased EPS guidance to $12.40-$12.65 from $12.30-$12.60. See our previously published call takeaways for read-thrus on the sector and our earnings summary highlights.
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During the call UNH again highlighted strong momentum across the business early in 2018. Particular focus on seniors, care delivery and Int’l. Mgmt sees ½ of population moving to highly evolved value-based arrangements 10 years from now with the company well positioned to identify and deliver high-performing providers using data / analytics and value-based contracting arrangements. UNH is targeting a 70 NPS average score across the enterprise over the next 5 years. Overall UNH remains one of our top ideas on the long side given best in class assets, biz momentum and management. Reiterate Outperform.
UNH reported 1Q’18 adjusted EPS of $3.04, above Wolfe/Consensus of $2.90 driven primarily by better than expected MLR and upside in Optum margins vs. our model. Total revenue of $55.2B (up 13.3% y/y, ~11% ex-HIF) vs. Wolfe/Consensus of $55.3B/$54.9B. Adjusted EPS guidance was increased to $12.40-$12.65 from $12.30-$12.60. Overall, the quarter should be well received given meaningful concerns around elevated flu costs and implies core trend remains benign, consistent with our NFP checks and JNJ’s reporting this morning of med device sales down 0.2% YoY in Q1’18. We see results here as a positive read through to the rest of the MCO group.
This afternoon (04/16/18) CNBC reported that Amazon is stepping back from its effort to sell / distribute pharmaceuticals to business customers including hospitals. The report notes that Amazon has found the pharma business more challenging than expected given difficultly winning business from traditional procurement channels (distributors and GPOs) and retail / delivery infrastructure that hasn’t been set up to deal with temperature-sensitive drugs. While Amazon could revisit the opportunity at a future date, the news is clearly a relief to incumbents in the pharmacy supply chain with PBMS (including UNH) / pharmacies / distributors all outperforming significantly post the news.
Ahead of UNH’s Q1 earnings release on Tuesday (4/10/2018) we have been getting questions about MLR guidance given potential flu impact, etc. At Nov 2017 Investor Day mgmt sized a 160bps MLR tailwind from HIF resumption, with an 80bps headwind from biz mix / other. Given 1Q17 MLR of 82.4%, this implies 1Q18 MLR of 81.6% all else equal. However with 4Q17 results in January UNH revised FY MLR upwards by 30bps to reflect the flow through impacts of tax reform, implying Q1 MLR of 81.9% before quarterly timing for PYD, HIF/MLR rebates and flu discussed below. All in after adding in moving parts we see MLR as possibly coming in closer to 82.0-82.5% depending on underlying trend (which our checks indicate is coming in positively for Q1’18) and other factors. While in focus, should most of any higher MLR be flu related we expect investors will look thru and we see minimal risk to $2.91 consensus given flexibility to #s from tax reform.
The U.S. Bureau of Labor Statistics released the March CPI report this morning and released the PPI report yesterday (4/10/2018). Recall the January CPI report showed a modest acceleration in both Medical CPI-U and PPI, driven by an uptick in the Hospital category. These data points caused some concern that MCOs could be facing a cost trend inflection point following several years of relatively benign trend backdrop. February results were mixed, and March results show a modest acceleration in the four metrics we track.
We are updating our price targets for both MCOs and Hospitals to reflect revised estimates for a handful of companies and recent M&A in the MCO space. As a reminder, our price targets are set on a relative basis to the NTM S&P 500 multiple using our 2019 estimates to arrive at year-end 2018 price targets. We value MCOs on a P/E basis and facilities on an EV / EBITDA less NCI basis. See page 2 for a full summary of price target changes and Page 12 for our price target build-up.
Yesterday (04/10/18), the Pennsylvania Commonwealth Court reversed the PA Department of Human Services’ decision to reject UNH’s protest of the HealthChoices Medicaid contract award. In his decision, Judge Michael Wojcik states that the December 19th 2016 meeting between CNC executives and state officials to discuss CNC’s operational readiness violated the rules governing the RFP process, despite the fact that the meeting was requested by PA officials. Next steps are unclear and it seems possible PA will need to issue this RFP for the 3rd time. This is a clear positive for both UNH and AET, who will likely have another chance to retain the business. While modestly negative for CNC we note that the company has been selected in both RFPs to date and would likely remain very competitive. Total contract spending is ~$12B and based on market share we estimate worth $1.1B to AET and $1.2B to UNH. See Exhibit 1 on Page 2 for market share. We note that this decision does not impact the recent Duals/MLTSS award to CNC, AmeriHealth and UPMC.
Last week U.S. District Judge R. David Proctor (Northern District of Alabama’s Southern Division) issued a ruling determining how allegations made in an antitrust lawsuit against Blue Cross and Blue Shield insurers will be evaluated. Judge Proctor ruled that BCBS’s use of exclusive service areas and output restrictions on non-Blue branded business (local / national best efforts rules) will be evaluated under Per Se standard of review (more below). This tougher legal standard is a setback for the Blues, although we note that the ruling on BlueCard was more favorable (again more below). From here we expect the BCBS Association to appeal fairly quickly with the court case itself likely coming sometime in mid to late 2019. Please email us for a copy of the ruling.
As previously discussed, over the weekend Politico reported that NY Governor Cuomo and state legislative leadership have agreed to a deal that would clear the way for CNC to acquire Fidelis. The article said that NY would get $2.0B from the sale, $500M from excess reserves (paid by CNC, more below) and $1.5B from sale proceeds (from the Catholic Church). Interestingly, the article includes a quote from Cardinal Timothy Dolan discussing the creation of a $3.2B charitable foundation with the proceeds – this implies total proceeds of at least $4.7B ($3.2B plus $1.5B to be paid to NY), above the initial $3.75B of consideration in the original deal terms. We think the difference here is explained by excess capital – we note that the asset purchase agreement only requires Fidelis deliver capital equivalent to 350% RBC to CNC upon close. See Exhibit 1 on Page 2 for the language from the asset purchase agreement. Audited Fidelis financials filed by CNC show $3.2B of cash and investments and $1.4B medical claims payable. Assuming 10% of LTM premiums = 350% RBC, we estimate capital retained post-sale by CNC = $970M ($9.7B x 10%), implying $850M of excess capital ($3.2B less $1.4B less $970M) in addition to the $3.75B purchase price. See Exhibit 2 on Page 2 for details.
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