Humana (HUM): Leadership In Medicare Advantage Underpins Recession-Resilient Value

Humana (NYSE:HUM) is the third-largest healthcare insurance company in the United States by revenue. With a focus on Medicare Advantage products, the firm has successfully established primacy in the $473bn MA market.

The company has recorded $92.92bn in 2022 revenues alongside a pretax income of $3.57bn. In spite of drawdowns driven by COVID-19 amongst other factors, Humana, alongside the rest of the health insurance industry, has managed to bounce back, with their $3.47bn in TTM FCF indicating strong fiscal health.

This only further proves my thesis on the inversive effects of a recession on the price action of Humana.

Introduction

The company is primarily engaged in two primary verticals; their traditional health insurance segment- encompassing individual and group MA plans, dental, vision, etc. products- which comprised $88.84bn in 2022 revenues, and CenterWell, the services aspect of the business, generating $17.31bn in yearly revenues. It is important to note that the two company activities overlap, further emphasizing their reciprocal nature.

Through these actions, Humana has recorded a 15% CAGR in EPS and 13% CAGR in consolidated revenues, superseding the 9.7% growth rate of the MA industry.

Valuation & Financials

General Overview

Humana’s consistent earnings growth has facilitated price appreciation superior to both the broad market and the health insurance industry as a whole.

Despite this growth, my belief is that the company remains fundamentally undervalued, being a financially sound business with a more operationally efficacious value chain than peers.

Comparable Companies

As the healthcare industry trends towards consolidation- both horizontal and vertical- Humana is increasingly faced with competition from larger organizations, including, but not limited to; UnitedHealth Group (NYSE: UNH), the leader in whole industry integration, CVS Health (NYSE: CVS), and Cigna (NYSE: CI). Though I remain bullish on Cigna, as described in a previous article, I believe Humana’s efficient and lean strategy lends itself better to economically volatile times.

As demonstrated above, Humana has sustained greater returns over the past year and half-year in spite of markedly different headwinds at both intervals.

On a multiples basis, however, Humana does not seem to stand out in any significant way; they record the second-highest P/E to growth, ROE, and book value per share.

Conversely, Humana’s relatively lower profit margin in spite of >10% CAGR in all segments indicates a growth first margin-second approach, illustrating the long-term potential of the company in margin expansion in conjunction with their ability to scale.

Valuation

According to my discounted cash flow model, at its base case, Humana’s stock is undervalued by at least 12%, with an intrinsic value of $570.07. Due to Humana’s debt-light capital structure, my model assumes a discount rate driven by a WACC of 8%.

The 5-year model further estimates highly conservative net margin growths of ~4%, given Humana’s strategic advantage in the MA segment.

This undervaluation is reinforced by Alpha Spread’s multiples-based relative valuation tool, which estimates an undervaluation of nearly 34%, with fair value being $763.69.

Thus, using a mean-based approach, the actual value of Humana should be $666.73, an undervaluation of 23% from today.

Why the Company Hedges Against a Recession

Healthcare as a Recessionary Safeguard

The case for the healthcare industry being a hedge against recessions is pretty intuitive; people will get sick regardless of economic circumstances, meaning healthcare products are highly inelastic, and therefore, while the demand for most other products goes down, it will not be for healthcare.

Such economic principles are backed up by significant data; the healthcare sector outperformed the early 90s, 9/11, and 2008 recessions by 16.7%, 8.8%, and 10.4% respectively.

The Humana ‘Advantage’

The inelasticity of demand for healthcare is all the more prevalent when considering government-funded programs in use by individuals. Any disincentive relating to diminishing purchasing power or delayed healthcare treatment is thus put aside, enabling sustained revenue generation.

In combination with demographic factors- such as the aging population- broader health trends, and continued government support for the MA program, Humana remains the best company to hedge against a potential recession driven by interest rate hikes and subsequently reduced purchasing power.

The company’s financial situation, with the lowest debt-equity ratio amongst peers, for instance, only fortifies this recession-resilient proposition.

Synergistic Investment in CenterWell and Core MA Projects Enable Growth

While Medicare Advantage enrolment at every level remains Humana’s primary focus, the company has been investing significantly in in-house vertical integration strategies, principally through their CenterWell platform. CenterWell encompasses many of Humana’s ‘payer-agnostic’ healthcare services capabilities, including senior-oriented primary care, pharmacy care, and homecare offerings.

Beyond supporting a wider and diversified TAM and revenue base, CenterWell’s value-based care can actually enable long-term cost-cutting and margin expansion. By empowering clients to leverage preventative health care measures, Humana can reduce costs to insured patients. The CenterWell platform- as of year-end 2022- operates 235 primary-care centres across the US, a 14% YoY increase. Humana expects $100mn-$200mn in primary care EBITDA alone by 2025 by continuing such expansionism.

Despite Humana’s rising promise across home care and primary care, its core business remains MA, in which they are dominant. And with 1 in 5 American adults expected to be retirement age by 2030, and an increasing percent of them opting for MA, Humana can only expect further scale growth.

Wall Street Consensus

My strongly bullish view on the company is supported by analysts, who project an average 1Y price increase of 20.37%, to $603.91.

Even at minimum projected performance, Humana is expected to experience an increase of 8.03% in its price, likely a product of undervaluation, resilience, and baked-in growth.

Risks

High Levels of Regulatory Stress

Due to the inherently interlinked nature between healthcare and governance, Humana is forced to navigate a complex and localized regulatory structure for each place it operates in. Any expansion is therefore met with a level of restrictiveness. Further political and regulatory stress may put downward pressure on profits and particular upwards pressure on costs.

Third-Party Dealings Induce Complexity

As a healthcare insurer, Humana must work with companies it provides insurance for individuals, unions, pharmacy benefit managers, federal, state, and municipal government, and many others. As such, any negative business impact on any of these partners may introduce negative pressures on Humana itself.

Significant Competitive Intensity

• Although the number of competitors is not significant due to the network effect and scale required in American health insurance systems, competitors that due exist are large in scale and have entrenched systemic advantages. Furthermore, as companies like CVS- through Aetna- or UnitedHealth- through Optum- work towards whole system integration, Humana becomes less convenient and is required to keep up with more deep-pocketed rivals.

Conclusion

In the short-term, the undervaluation of Humana, in addition to its recession-resilient nature- even among healthcare companies- will prompt positive price action.

In the long-term, the macro growth of the Medicare Advantage program, in which Humana remains a distant leader, and the growth of their CenterWell primary care, pharmacy care, and home care platforms are highly bullish indicators.

Editor’s Note: This article was submitted as part of Seeking Alpha’s Best Investment Idea For A Potential Recession competition, which runs through April 28. This competition is open to all users and contributors; click here to find out more and submit your article today!