- By Robert Abbott
Centene Corp. (NYSE:CNC) is a health insurance company that specializes in government-sponsored health care programs. In addition to Medicaid and Medicare products, it offers commercial programs and Marketplace operations.
Investors will see a fast-growing and undervalued large cap. Based in St. Louis, it has a market capitalization of $35.66 billion.
Here's an overview of the company from a presentation to the 38th Annual J.P. Morgan Healthcare Conference last January:
Management of the FPA Capital Fund wrote in a commentary last January, "Centene has been very successful in winning contracts and growing revenues. Their success is due to their large investments in systems, strong balance sheet, and prudent capital allocation."
That strategy has paid off; in the past three years, the revenue growth rate has averaged 12.8%, the Ebitda growth rate has averaged 10.2% and the earnings per share without NRI growth rate has averaged 22.5%.
Free cash flow also has been on an upward trajectory, although quite a bumpy one, over the past six years:
Since Centene does not pay a dividend and has not bought back shares in the past three years, that's made quite a bit of free cash flow available for growth and acquisitions. The most notable initiative in recent years was its purchase of WellCare Health Plans Inc.
The $19.6 billion acquisition, completed in January of this year, is expected to provide several benefits, the more important being the ability to add a Medicare prescription drug plan to its existing business lines. In its third-quarter earnings call, Centene said it expected it would "generate the mid- to upper single-digit accretion from the transaction" it previously projected.
That would be on top of the already robust growth in revenue, Ebitda and earnings per share we noted above. Centene listed what it perceived as its competitive strengths in its 10-K:
Expertise in government-sponsored programs.
Quality and innovation.
Innovative technology and scalable systems.
Financial strength and scale.
Diversified business lines.
Localized approach with centralized support infrastructure (in dealing with medical providers).
Value investors should note the company has a significant debt load, with a cash-to-debt ratio of 0.76 and interest coverage of 5.14. The latter is at the bottom end of acceptability for followers of Benjamin Graham.
Overall, an ambitious management team has made Centene a fast-growing, quality company. But is its stock affordable?
Several valuation measures indicate it is, though perhaps not a great bargain. The GuruFocus Value chart agrees with that assessment:
Centene's price-earnings ratio of 17.14 is right in the middle of all companies in the healthcare plans industry and well below its 10-year median of 21.16.
Similarly, when we look at the price-earnings ratio in the context of Ebitda growth, we also get a modestly undervalued rating. That's the PEG ratio (price-earnings divided by five-year Ebitda growth), which comes in at 0.82 (where 1.00 equals fair value).
And because Centene has a high predictability ranking, 4.5 out of five stars, we can have some confidence in the discounted cash flow calculation (using default settings):
Based on the relative consistency of these metrics, we could assume that Centene is modestly undervalued at current price levels.
What about its competition? There is a lot of it, coming from many sources, as described in the 10-K:
"We compete for members principally on the basis of size and quality of provider networks, benefits provided and quality of service. We compete with numerous types of competitors, including other health plans and traditional state Medicaid programs that reimburse providers as care is provided, as well as technology companies, new joint ventures, financial services firms, consulting firms and other non-traditional competitors."
Here are some of the biggest, as shown on Centene's summary page at GuruFocus:
Of this group, four are bigger by market capitalization:
CVS Health (NYSE:CVS): $90.85 billion.
Anthem (NYSE:ANTM): $77.18 billion.
Cigna (NYSE:CI): $73.64 billion.
Humana (NYSE:HUM): $51.41 billion.
As the company noted, competition is based on the size and quality of provider networks, so Centene faces headwinds in growing its commercial business.
However, it has size and expertise advantages when competing in government markets, so we might have at least some confidence that the company can maintain its above-average growth rates.
The gurus have been both buying and selling Centene shares, but buying has been markedly lower since the end of the first quarter of this year (when the WellCare acquisition was completed):
The three biggest holders, among the 12 gurus with stakes in Centene, at the end of the third quarter were:
Andreas Halvorsen (Trades, Portfolio) of Viking Global Investors with 17,445,560 shares, representing 3.01% of Centene's outstanding stock and 3.68% of his fund's capital. He increased his share count by 8.31% in the quarter.
Pioneer Investments (Trades, Portfolio), which made a bigger commitment, increasing its share count by 72.45% to 1,950,506 shares by Sept. 30.
FPA Capital owned only 165,984 shares, after an increase of 12.47%, but has made a major commitment with 9.06% of its total assets managed invested in Centene.
The big commitment by FPA Capital seems justified based on what we see in Centene's financials and valuation metrics. All four valuation metrics we reviewed were consistent in indicating at least modest undervaluation. More aggressive investors might put more weight on the DCF valuation that suggests there is a sizeable margin of safety.
The growth story is also robust, with above-average growth in revenue, Ebitda and earnings per share over the past decade. It also has an above-average metric in its debt load, as measured by its interest coverage ratio. Additionally, the WellCare acquisition should help Centene continue that growth, along with its proven strategy for organic growth.
Value investors will want to tread warily here because of the debt, but may find the share price attractive. Growth investors may like the 10-year growth rate and entry price. Income investors will pass Centene by because it does not pay a dividend.
Disclosure: I do not own shares in any of the companies named in this article and do expect to buy any in the next 72 hours.
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This article first appeared on GuruFocus.