Cigna (CI +0.00%) is an odd duck in the managed care world. Managed care is certainly about managing costs, but it is also about pricing risk; Cigna's approach appears to be avoiding risk when possible, as the company has the smallest risk-based premium business of the major managed care companies. Not unlike UnitedHealth (UNH 1.22%), Cigna is looking to a diversified array of businesses, including international expansion, to help fuel growth. Also, very much unlike Aetna (AET +0.00%), WellPoint (WLP 0.27%), and Humana (HUM 0.12%), Cigna has chosen to be quite cautious with its initial forays into the Obamacare exchanges.
Largely On The Sidelines For The Affordable Care Act
Like UnitedHealth and Health Net (NYSE: HNT), Cigna has taken only a bare minimum approach to the new public exchanges under the Affordable Care Act, also known as Obamacare. Cigna is active in only five exchanges (Arizona, Colorado, Florida, Tennessee, and Texas), making it one of the least-involved managed care companies.
I see at least two reasons for this. First, there was a great deal of uncertainty as to what the enrollments and risk pools were going to look like in the early years of the process. With the assumption being that those most likely to sign up are those who are going to use the most health care, Cigna has chosen to play it safe and establish just a token presence in the markets. Seeing as how enrollment trends in the under-34 age group are below expectations (around 30% signing up instead of the hoped-for 40%), that may prove to be a margin-sparing move for Cigna in 2014 even with the risk mitigation options offered by the federal government.
Second, it's also worth remembering that Cigna doesn't have a particularly large funded (at risk) individual risk business. Roughly 85% of the company's covered lives are service arrangements where Cigna doesn't take on risk. As companies like Aetna and WellPoint are far bigger players in individual and funded risk, it would stand to reason that they'd be much more active than Cigna.
Banking On Medicare
Medicare, and particularly Medicare Advantage, is a big deal to all of the major managed care companies, but Cigna seems to be focusing a lot of attention here. With the graying of the boomer generation, Medicare enrollments are going to be rising in the not-so-distant future. At the same time, though, there are likely to be a lot of disruptions in the market in 2014 and reimbursement pressures could well hurt the smaller operators – giving rise to acquisition opportunities for companies like Cigna.
Unlike WellPoint and UnitedHealth, though, Cigna is not a major player in Medicaid and really not looking to be. Although Medicaid-oriented names like Molina (MOH +3.24%) and WellCare (WCG +0.00%) have gotten attention from time to time as acquisition candidates, Cigna's management has made comments that indicate they'd only really be interested in acquiring into Medicaid if it also provided a significant gateway to dual-eligibles (those eligible for both Medicaid and Medicare).
Overseas Is Significant, And Getting More So
UnitedHealth has gotten some positive attention for its large foray into the Brazilian health insurance market, but Cigna has been making international expansion a priority for some time now. Operations outside the U.S. comprise about one-tenth of the company's earnings base, with operations largely focused on South Korea and Taiwan today. Cigna has also entered markets like Brazil, Indonesia, Turkey, and China, and will be entering India in 2014. Although many of these foreign markets are regulated and have state-funded universal health care offerings, there is a growing demand for supplementary coverage that gives policy holders access to different levels of care and/or different providers (essentially allowing for a wider range of services and faster service times).
Strong Growth Potential
Cigna has gone to great lengths to build up business lines that are outside of the current scope of reforms. While the next couple of years are still likely to be turbulent and erratic, Cigna management believes they will be a rare grower in the field. Moreover, I like Cigna's chances for above-average long-term growth, given the large base of business outside of traditional risk-based premiums.
I believe Cigna can deliver top-line growth in excess of 7% over the long term, with stronger free cash flow margins than it peers. That leads me to estimate a DCF-based fair value of almost $125 today. Looking at an excess returns model, I do believe that Cigna should consider deleveraging a bit, but I believe the company's diverse service-heavy business mix can keep ROE in the high teens, suggesting a fair value north of $110.
The Bottom Line
Like Aetna, Cigna seems significantly undervalued though you perhaps could not find two more different business models at present (or at least with respect to embracing public exchanges). I do like the foothold that Cigna is building overseas, and this would be a name I'd still consider at these levels.
