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Morningstar | We're Pleased With Anthem's First-Quarter Results; Shares Undervalued

Narrow-moat Anthem reported first-quarter results that put the firm on track to meet our full-year expectations. We don’t intend to make many changes to our model and will likely leave our $306 per share fair value estimate unchanged, implying roughly 16 times our 2019 adjusted earnings forecast. Following the underperformance of the managed care industry over the last several weeks, we think Anthem shares represent an attractive opportunity for investors with a long-term horizon. While political noise has been the primary driver of stock underperformance, in our view, we contend the likelihood of legislation like recent "Medicare for All" proposals passing remains quite low. At current valuations we think the market is taking a too-pessimistic view of the managed care industry, and investors willing to look past campaign rhetoric have an opportunity to own these moatworthy businesses at discounted prices.

Anthem's quarterly performance was in line with our expectations despite some variability within expense line items. Risk membership accounted for the bulk of the firm's roughly 3% membership growth year over year, consistent with management's strategy. Commercial group coverage appeared to expand by a low-single-digit percentage, by our estimate, compared with mid-single-digit declines over the course of 2018. Anthem's Medicare Advantage business was also a standout, increasing covered lives by nearly 14% versus the end of 2018. This compares with the overall MA market that has expanded by roughly 5% year to date, suggesting meaningful market share gains for the enterprise.

On the cost side of the equation, the firm's medical loss ratio of 84.4% came in worse than our expectations, offset by operating costs that were lighter than we anticipated. The higher-than-expected increase in MLR is likely attributable to mix effects as government-sponsored membership continues to outstrip commercial growth, and weaker Medicaid profitability out of a handful of states.

Anthem's launch of its internal pharmacy benefit management offering remains on track, with the first membership cohorts expected to be migrated to the platform starting in May. This will be somewhat lengthy process as membership in the firm's Medicare and ACA-compliant individual businesses won't begin the transition until Jan. 1 of next year. Nevertheless, the company should begin to reap the cost benefits of owning its own PBM offering beginning in the second half of 2019 and into 2020, with the opportunity to take on third-party contracts thereafter.