Value investing can be a powerful strategy. Buying businesses for less than they are worth can limit your risk of significant capital losses, and it can increase your chances of future upside.
The tough part of value investing is that not all cheap stocks prove to be the value they initially appear to be: Some stocks are beaten down for one or more valid reasons (i.e., declining revenue/profits or high debt loads). These stocks are referred to as value traps.
The health insurer Centene (CNC -2.22%) looks to be a legitimate value stock. Here is why it appears to be a clear buy for value investors.
Centene's business is thriving
With a total medical membership base approaching 30 million members across its Medicare, Medicaid, Health Insurance Marketplace, and Tricare military health insurance plans, Centene is a major health insurer. The company's status as the largest Medicare-managed care company in the United States helped get it to its current $39.5 billion market capitalization.
| Metric | Q2 2022 | Q2 2023 |
|---|---|---|
| Total medical membership | 26.4 million | 28.4 million |
| Net margin | 2.9% | 3.1% |
| Diluted shares outstanding | 583.6 million | 550.3 million |
Data source: Centene.
Centene reported $37.6 billion in total revenue during the second quarter (ended June 30), which was good for a 4.7% year-over-year growth rate. Growing enrollment in Medicaid, Marketplace, and Medicare plans made up for a slight decline in the company's Tricare membership for the quarter.
Centene's non-GAAP (adjusted) diluted earnings per share (EPS) soared 18.6% over the year-ago period to $2.10 in the second quarter. Due to measured control of its costs during the quarter, the company's total operating expenses rose by just 1%. This is what helped the St. Louis, Missouri-based health insurer's net margin to expand by roughly 20 basis points for the quarter. Paired with a significant share-buyback program that lowered the outstanding share count, that is why adjusted diluted EPS growth greatly outpaced total revenue growth in the quarter.
Despite the wave of Medicaid redeterminations that began in the first quarter in all 30 states where Centene has operations, its fundamentals seem to be intact. This is because the company's preparations over the last 18 months led to 9 million outreach attempts to medical members so far in 2023, with higher-than-normal member engagement. For context, Medicaid redetermination is a fancy way of saying that people on Medicaid plans need to verify that they are still eligible for Medicaid coverage based on income requirements and sometimes asset tests. Analysts are optimistic that the company will recapture these members in the months ahead, which is why 11.2% annual adjusted diluted EPS growth is expected over the next five years. This is just about in line with the healthcare plan industry average annual earnings growth forecast of 11.7%.
Image source: Getty Images.
Centene possesses a rock-solid balance sheet
Centene is a fundamentally solid business. And if that wasn't enough, the company also sports a robust balance sheet. It is predicted that Centene's net debt position will come in around $3.4 billion in 2023. When measured up to the $5.2 billion in earnings before interest, taxes, depreciation, and amortization (EBITDA) that is expected for the year, this equates to a net-debt-to-EBITDA ratio of just 0.6. This financial strength is important because it can juice the company's growth prospects with the flexibility for acquisitions moving forward.
A valuation that comes with downside protection
As a result of concerns surrounding Medicaid redetermination, Centene stock shed 17% of its market value thus far in 2023. This isn't pleasant news for shareholders who began or added to positions in the stock recently. But for those yet looking to open a position in the stock, now could be the time to pounce.
Centene's forward price-to-earnings (P/E) ratio of 10.2 is deeply discounted to the healthcare plan industry average forward P/E ratio of 13.9. Such a sizable discount to its industry peers could limit further downside and fuel capital gains. This explains why analysts have an average $84 12-month share price target for Centene, which offers big upside from the current $68 share price.
