It's hard to believe that a Fortune 50-sized company can fly under the radar, but that is exactly where Missouri-based Centene Corporation (CNC 0.67%) finds itself. The health insurer has over 25 million members, operates in over 30 states, and forecasts about $115 billion in total revenues for 2021. Centene is the largest provider of government-sponsored Medicaid insurance in the country, and the top-ranked insurer on the health insurance exchange created under the Affordable Care Act (ACA).
Most importantly, a series of recent acquisitions has significantly expanded and diversified Centene's geographical reach and business mix. It is no longer simply the "one-trick Medicaid pony" of years past. Yet its stock price continues to trade at a significantly lower valuation compared to its industry peers, notably Cigna (CI 2.59%), United Healthcare (UNH 0.84%), and Anthem (ANTM 1.69%).
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Scaling via acquisitions, diversification, and technology
Centene's growth story gained speed beginning in 2016 with its $6.8 billion acquisition of Healthnet, Inc., which vaulted the combined entity into the number one spot among Medicaid insurance providers. That was followed closely by Centene's $3.75 billion purchase of Fidelis Care in 2018, which gave the company access to the New York State territory, a top four marketplace for government-sponsored health services.
2020 was even busier, and brought a huge milestone for the company. Centene gained entry into the lucrative specialty pharmacy sector with its purchase of PantherRx, a niche provider of orphaned drugs and rare disease medications.
But the real blockbuster deal last year was its $17.3 billion merger with WellCare Health Plans. That transformative deal further balanced Centene's growth prospects by providing an initial presence of over 1 million members in the rapidly expanding Medicare insurance sector. However, the key to the WellCare merger was the ability to achieve enhanced scale as the combined entity instantly grew by over 10 million members and $40 billion in revenue.
Managed care providers compete largely on the basis of cost efficiencies, broad geographical reach, diversified service offerings, and the ability to withstand government price constraints. The Centene/WellCare merger checked all those boxes for the newly formed entity, and vaulted it into the top tier of medical insurers.
Not to rest on its laurels, on Jan. 4, Centene announced the $2.2 billion purchase of Magellan Healthcare (MGLN +0.00%). This bolt-on type transaction adds over $4 billion in revenue to its diversification efforts, primarily in the strong growth areas of behavioral health and pharmacy services.
Lastly, the COVID-19 pandemic has generated an unexpected technology boost (and cost savings) to Centene's fortunes. During its most recent investor day presentation, the company revealed that it had conducted over 50% more health assessments of its members in 2020 versus the prior year, with over 90% of them occurring via telehealth technology.
In total, telehealth visits were up 3,000% at the peak of the pandemic, because they are a far more efficient and cost-effective utilization of resources than in-person appointments.
Merger activity leads to investor excitement
Centene's $60 per share price is cheap on several metrics. With a forecasted 2021 earnings per share (EPS) of $5.15 at the midpoint of guidance, we're looking at a modest 12 times price-to-earnings (P/E) ratio. That valuation is below both its historical average of around 14 to 15 times earnings, and the high teens to 20 times ratio of its peer group mentioned above, plus the low 20s market multiple for the rest of the stocks on the S&P 500.
To be fair, this undervaluation can be attributed to several factors. The first is investors' desire to see how the integration of all these new entities plays out in terms of profitability. Centene has forecasted mid- to high single-digit revenue growth in the coming year, with low double-digit EPS growth, both slightly below historical trends for the company. Just recapturing a 15 times P/E multiple would take the stock price back up to its 52-week high of $75 per share, for a 25% gain.
Another drag on its stock performance has been the twin factors of a zero dividend policy and an absence of a stock buyback program. Instead, the company has chosen to preserve its balance sheet integrity and credit ratings by using free cash flow to pay down its acquisition debt and maintain its regulatory capital requirements. Over time, one should expect those negatives to abate, which will further enhance long-term share price appreciation.
Other tailwinds at Centene's back
The knock on Centene has always been its over-reliance on government-sponsored health insurance programs. I believe that to be an overly simplistic view of the situation. On a more positive bent, the recent Supreme Court decision to preserve the core of the ACA is a net positive for medical care providers of all stripes by providing continued healthcare insurance coverage to tens of millions of Americans.
Moreover, given the new Biden Administration focus on COVID-19 vaccination programs, it is unlikely to pursue other detrimental price policy restrictions on the healthcare industry at a time when their financial wellbeing is of paramount importance to that effort.
Other parts of the pandemic stimulus package are targeted to the expansion of state Medicaid enrollment incentives via federal subsidies and other initiatives. This will directly benefit Centene as the largest purveyor of that type of insurance. The expected surge in Medicare enrollments in the coming years as the baby boomer generation ages past 65 will also benefit Centene, given its growing presence in that sector.
Finally, one potential positive wildcard is just starting to play out. Beginning Jan. 1 of this year, hospital systems are now required to publicly disclose their price lists for a range of medical procedures. This unprecedented price transparency has quickly revealed a wide range of charges for the exact same service depending on the insurance carrier.
As has historically been the case in many other industries, true price discovery always leads to lower costs over time. This will undoubtedly benefit the insurance industry in the future, to the detriment of medical service providers in terms of lower reimbursement costs to their membership.
Taking into account all of the above, Centene represents an attractive long-term value play, with far less risk than other expensive growth stocks with the healthcare space. Its growth via acquisition strategy should prove to be an excellent business model to drive future share price appreciation.
