EUR 850.00 For Business Accounts Only

Morningstar | Humana Reports a Good 2Q as Partnerships Will Help It Control Long-Term Costs

We believe Humana is on the right track operationally, as the recent 40% acquisition of Kindred home-health operations and clinical partnerships with Walmart and Walgreens position the firm advantageously from a medical cost perspective. The firm’s membership book skews heavily toward the Medicare cohort, which carries a higher cost of care than most others in the U.S. However, we believe Humana is building a solid directly owned synthetic provider network through its numerous provider/retailer joint ventures and partnerships. From our perspective, this dynamic will give Humana increased control over the direct treatment of its members and will allow it to ultimately better control its overall medical costs. Factoring these variables into our model has led to slightly better operating margins in our out-years. Given these developments we are increasing our fair value estimate for Humana to $215 from $191; however, we still believe the firm’s equity remains greatly overvalued as its current stock price implies margin expansion significantly above our outlook. Even with the positive strategic moves, we have modeled moderate operating margin expansion over our explicit forecast given our medical cost outlook for the overall Medicare cohort. Accordingly, we are also reiterating our no-moat rating for Humana.

Overall, we believe management is implementing a solid strategic plan that not only includes several value-creating partnerships, but it has also actively sought to divest its noncore businesses. These include its sale of its closed-block long-term care operations and certain non-health-insurance products. Additionally, the firm’s non-Medicare individual membership decreased to 0 for the year and management’s strategy to wind down this cohort was a solid strategic move.

Nevertheless, we believe Humana will need to manage its overall centralized costs more efficiently. The firm reported a 180-basis-point increase over year-ago levels (to 12.5%) for its operating cost ratio. We would note a material portion of the increase was tied to the reinstatement of the health insurance fee. However, the servicing of the expanded Tricare contract and other employee investments also weighed on this metric. We expect this ratio to decrease over the coming years and have modeled materially lower selling, general, and administrative costs compared with the firm’s historical average, which offsets our outlook for moderately increasing medical costs. We believe this dynamic is key to the long-term success of Humana.