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Obamacare Is a Disaster, but Centene Stock Just Got Upgraded: 3 Things You Need to Know

By Rich Smith - May 26, 2016 at 12:30PM

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The main thing: When the profits are this good, the big picture doesn't matter.

Obamacare is a disaster...for corporate profitability. Around the country, insurers are losing money, and asking for permission to raise rates to cover their costs of insuring upwards of 12 million sicker-than-average Americans. To give you an idea of how bad things are getting, this morning, The Wall Street Journal reported that Anthem (ANTM 2.71%) is seeking a 16% rate hike in Virginia, Blue Cross wants 20% in Washington State, and in Georgia, Humana (HUM 2.33%) is seeking an increase of 65%!

At the same time, CNBC reports that "Centene (CNC 1.89%) is one of the few insurers making money on Obamacare plans." And now Centene has won an upgrade.

Here's what you need to know.

Thing No. 1: Stifel loves Centene

As reported on this morning, Stifel Nicolaus has just upgraded shares of St. Louis, Missouri-based Centene from hold to buy. The analyst also stuck a $75 price target on Centene stock, and calculated from today's share price of $60 and change, that implies that new buyers could enjoy as much as a 25% profit as Centene stretches to reach Stifel's new target price.

But why?

Thing No. 2: Because Centene is growing

Key to Stifel's buy thesis is the analyst's belief that after having swallowed rival Health Net, Centene is poised to grow in a market where other insurers are pulling in their horns. "Centene," says Stifel, "is well positioned to ... continue to win its fair share of the sizable growth opportunity in Medicaid, strategic Medicare Advantage markets, programs at the confluence of both Medicare and Medicaid, and growing health insurance exchange marketplace."

Centene stock is also "trading at very attractive levels," says the analyst. If Centene can hit its targeted earnings for this year -- $2.45 to $2.80 per share -- then the stock could be a bargain.

Thing No. 3: Stifel might be right

Centene stock reported earnings of $2.22 per share over the past 12 months, giving the stock a not particularly cheap-looking P/E ratio of 27.4 today. Maxing out projected earnings at $2.80, however, would put the stock's current share price at about 21.7 times this year's hoped-for earnings.

If you give any credence to the possibility of that happening, $2.80 per share would work out to a growth rate of 26% annualized. And at the risk of stating the obvious, even a high-sounding P/E ratio of 21.7 doesn't seem so unreasonable to pay for a 26% grower (it works out to a PEG ratio of just 0.8).

After all, rival health insurers Anthem and Humana sell for PEG ratios of 1.3 and 1.7, respectively. That makes Centene look like a relative bargain.

And one more thing...

Of course, the consensus on Wall Street is that Centene will not grow at 26%. Yahoo! Finance data suggests a long-term growth rate of 18% is more likely. But even so, you don't have to assume that Stifel Nicolaus is right, and everyone else is wrong about the growth rate, to see a strong argument for buying Centene stock.

The reason is that while Centene shares look pricey when valued on GAAP earnings, they're actually not expensive at all when valued on the real cash profits -- the free cash flow -- that Centene is generating. According to data from S&P Global Market Intelligence, Centene generated positive free cash flow of $640 million over the past 12 months. That's twice reported net income, and enough cash to value Centene stock at just 16.2 times FCF.

To justify that valuation, you don't need to assume 26% growth. The consensus estimate of 18% works just fine.

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Stocks Mentioned

Centene Corporation Stock Quote
Centene Corporation
$86.21 (1.89%) $1.60
Anthem, Inc. Stock Quote
Anthem, Inc.
$482.58 (2.71%) $12.71
Humana Inc. Stock Quote
Humana Inc.
$478.96 (2.33%) $10.89

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