The year 2015 so far has been strong for the health insurers, who continue to benefit from growth led by the Affordable Care Act (ACA) driven Medicaid expansion as well as public exchanges, a benign flu season and a lower-than-expected medical utilization rate.
At first glance, the health sector has reverted to historical patterns of bouncing back as the nation recovers from economic doldrums. Either due to free spending because of the step-up in economy or shopping with the moral backing that ACA insurance has given, consumers primarily set fuel to the growth engine for the sector.
Insurers witnessed an overall rise in enrollment largely made possible by the launch of public health insurance exchanges in Oct 2013. The expansion of Medicaid also turned out to be a boon for the health insurance industry. The exchanges brought big business for insurers like Aetna Inc. AET and Anthem Inc. ANTM (formerly known as WellPoint), which enrolled customers in flocks in 2014. The trend continues this year, too.
Healthy top-line growth is also expected in segments such as Medicare Advantage and Medicaid. For the private Medicare Advantage, baby boomers reaching 65 should offer a secular growth tailwind as seniors continue to prefer this product to the government-run Fee-for-Service offering.
The health insurance industry business model is driven by medical utilization (U.S. demand for healthcare services). It was expected that an improving economy will cause millions of insured Americans to access medical care at a higher degree causing a sharp spike in medical utilization ratio, consequently leading to higher claim payment which erodes the bottom line. However, the utilization rate year to date came out lower than expected, thereby shielding the margin of the health insurers.
Moreover, the drug Sovaldi, an expensive cure for Hepatitis C increased the medical cost trend the most in 2014, and hit the insurers hard. Nevertheless, Hepatitis C is now viewed as a driver of earnings for the industry players as they have received reimbursement in government programs and negotiated better unit costs with suppliers.
Insurers’ earnings are also expected to see accretion from their international operations. Some of the players – Aetna, Cigna Corp. CI and UnitedHealth Group Inc. UNH – have extended their business beyond the national boundaries in the wake of stringent regulations back home. However, a strong U.S. dollar will be a drag on the earnings of the players.
The growth outlook for the industry is also being dictated by inorganic growth driven by mergers and acquisitions as players seek to beef up market share.
Moreover, strong balance sheets with low leverage and attractive organic cash flow generation, along with excess capital in the form of statutory reserves and parent cash continue to make this an attractive sector.
Industry Fundamentals = Earnings Beat?
Overall, the health insurance scenario looks supportive for its players. Thus, it may be a good idea to look at some companies in the health insurance sector that have the potential to beat earnings with their upcoming releases. These stocks are well positioned in today’s market, and could see considerable upside riding on the aforementioned trends. An earnings beat should help these stocks gain investor confidence and show favorable price movement.
How to Pick?
Given a large number of industry participants, pinpointing stocks that have the potential to beat estimates could appear to be a daunting task. But our proprietary methodology makes it fairly simple.
One way to narrow down the list of choices this earnings season is by looking at stocks that have the combination of a favorable Zacks Rank #1 (Strong Buy), #2 (Buy) or #3 (Hold) and a positive Earnings ESP.
Earnings ESP is our proprietary methodology for identifying stocks that have high chances of surprising in their next earnings announcement. It shows the percentage difference between the Most Accurate estimate and the Zacks Consensus Estimate.
Our research shows that for stocks with this combination, the chance of a positive earnings surprise is as high as 70%.
Below are two health insurance stocks that we believe are best positioned to stand out this earnings season.
Humana Inc. HUM has a Zacks Rank #2 and an Earnings ESP of +0.79%. The Zacks Consensus Estimate for the first quarter stands at $2.54 per share. Humana will announce first-quarter results before the opening bell on Apr 29.
Another stock worth considering is Cigna with a Zacks Rank #2 and an Earnings ESP of +0.54%. The Zacks Consensus Estimate for the first quarter stands at $1.86 per share. Cigna will announce first-quarter results before the opening bell on Apr 30.
WellCare Health Plans, Inc. WCG has a Zacks Rank #3 and an Earnings ESP of +7.14%. The Zacks Consensus Estimate for the first quarter stands at $0.28 per share. WellCare will announce first-quarter results before the opening bell on May 6.
Moving Forward
Though the players are strongly poised now, investors eyeing a long-term investment perspective should note that the Supreme Court will soon hear the case challenging the subsidies made available by the ACA. If the court rules in favor of the opponents, President Obama’s signature achievement may be seriously threatened, causing a sharp decline in subsidized enrollment, placing health insurers in a difficult position. However, until such a situation arises, these earnings plays ensure gains for investor.
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