Aetna the Undaunted Insurer
- By Mark Yu
Aetna (AET) delivered its third-quarter earnings results last Thursday. The $38 billion health insurer delivered 4.72% sales growth to $47.4 billion and 3% profit growth to $2.1 billion three quarters into 2016. Aetna's shares were almost flat at -0.08% while the broader Standard & Poor's 500 index closed -0.5%.
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The intrinsic value of AET
Mark T. Bertolini, Aetna chairman and CEO:
"Our third-quarter performance is a testament to our long-term strategy, which we expect will drive solid operating results for the remainder of 2016 and beyond.
"We will continue to sharpen our focus on participation in key industry growth drivers, while helping lead the move to value-based care and transforming Aetna into a more consumer-centric company."
Shawn M. Guertin, Aetna executive vice president and chief financial officer:
"Solid performance among our core businesses and a focus on managing general and administrative expenses have once again offset pressure from our ACA-compliant products, resulting in a strong third quarter for the company and our shareholders.
"Operating results in our government business in particular remain robust, and recently released data show that among peers Aetna has the highest percentage of Medicare members enrolled in plans with an overall 2017 rating of four stars or higher."
Market performance
Aetna's five-year total return was exemplary at 22.4% while the S&P 500 returned 13% (1). Year to date, Aetna lost its lead over the index with 0.25%, compared with 5.88% return.
Valuations
Aetna had a trailing 12-month price-earnings (P/E) multiple of 15.9 (industry median: 17), price-book (P/B) value multiple 2.1 times (industry median: 2.4) and price-sales (P/S) ratio of 0.6 times (industry median: 0.5) (2). Trailing 12-month dividend yield was at 0.93% with a 15% payout ratio.
(Aetna, Annual Filing)
Aetna
Aetna is a 163-year-old American managed health care company. In its filing, Aetna is one of the U.S.' leading diversified health care benefits companies. The company serves an estimated 46.7 million people with information and resources to help them make better informed decisions about their health care (3).
Aetna's customers include employer groups, individuals, college students, part-time and hourly workers, health plans, health care providers, governmental units, government-sponsored plans, labor groups and expatriates.
Aetna is in the midst of an ongoing acquisition, pending government review, of another insurer, $25.5 billion Humana (HUM). Humana agreed to be taken over for a price tag of $37 billion. The company projects that the acquisition will do the following: add medical membership which will enhance Aetna's geographic profile and diversified portfolio; increase its presence in government programs; and enhance Aetna's consumer capabilities and provider engagement efforts.
In 2015, Aetna stated that it intended to reduce its participation in the number of health care exchanges, from 17 to 15. But in mid-August this year, Aetna further wanted to eliminate most of its exposure from the exchanges. The insurer now will stop offering policies on the exchanges in 11 of the 15 states where it currently operates.
Aetna stated that it had lost $430 million since the health care exchanges, under the Affordable Care Act, opened in January 2014. As it turned out, health care exchange participants were sicker and costlier than expected and that Aetna, along with its peers, criticized the federal program designed to mitigate those risks.
Uncertainty remains whether the insurers are to receive support as a majority in Congress wants the Affordable Care Act to fail, according to the CNN Money. Nonetheless, Aetna's willing to come back to the exchanges whenever the federal government makes improvements in the health care program.
(Department of Justice and State Attorneys General Sue to Block Anthem's Acquisition of Cigna, Aetna's Acquisition of Humana, The Justice Department)
Even prior to its recent earnings release, the Department of Justice did not like the concentration of power among the supposed big three. Further, Assistant Attorney General William Baer said the two mergers would leave consumers at risk by reducing benefits and raising premiums.
Still, Aetna issued $13 billion in debt to partially fund its deal with Humana in the quarter ending in September.
Aetna has three business segments: Health Care, Group Insurance and Large Case Pensions. The company derives its revenues primarily from insurance premiums, administrative service fees, net investment income and other revenue.
Health Care
The Health Care segment provides a full range of insured and self-insured medical, pharmacy, dental and behavioral health products and services (5). The Health Care segment received much business from the federal government. In 2015, 31%, or $17.7 billion, of the segment's revenue was derived mostly from contracts with Centers for Medicare & Medicaid Services (CMS), followed by revenue collected from the federal employee-related benefit programs and ACA programs.
The segment contributed 94.8% of total Aetna sales for fiscal 2015, including investment income received in the period. The Health Care segment also grew by 4.6% to $57.2 billion from the previous year and delivered 4.7% operating margin.
Nine months into 2016, the Health Care segment grew 4.7% to $44.9 billion compared to the same period last year and delivered 5.3% operating margin.
Group Insurance
The Group Insurance segment includes group life, disability and long-term care products (6).
The segment grew by 1.2% and contributed 3.7%, or $2.2 billion, to total FY 2015 sales with a 6.1% operating margin. Nine months into 2016, Group insurance grew 0.3% to $1.68 billion and had a 5.4% operating margin.
Large Case Pensions
The Large Case Pensions segment manages a variety of retirement products (including pension and annuity products) primarily for tax-qualified pension plans (7).
The segment grew -51.7% to $270.1 million in 2015 while carrying a good 40.9% operating margin. Three quarters into 2016, Large Case Pensions grew 11.5% to $38.9 million and delivered 23.4% operating margin.
Acquisitions
Aetna also engaged in several acquisitions in recent years. One of which was the company's acquisition of Coventry Health Care for $5.7 billion in 2012. Coventry's business operations were folded into Aetna's Health Care segment, according to company filings. Meanwhile, the Wall Street Journal reported that Aetna's acquisition of Coventry expanded the former's reach into government-based health plans, such as business with the CMS.
Medical Benefit Ratio (MBR)
An MBR (also known as a medical loss ratio) is the amount of premium revenue spent on medical care and services (8). In 2015, Aetna delivered an overall 80.8% MBR to satisfy the Affordable Care Act threshold. Nine months into 2016, Aetna's MBR ran at 81.7%, 120 basis points higher than same period last year.
Overall, Aetna grew its sales and profits by 12% and 6.2% over the past five years
Outlook
(Aetna's fiscal 2016 guidance, quarterly filing)
In estimation, Aetna expects its fiscal 2016 sales to grow by 4.4% to $63 billion year on year (YOY) while its profits to grow by $17.2% to $2.8 billion year over year.
Aetna also expects its earnings per share to be between $7.95 and $8.05 for fiscal 2016.
Cash, debt and book value
Unaudited balance sheet figures as of Sept. 30 indicated that Aetna had $22 billion in cash and short-term investments and $20.7 billion in debt (debt-equity ratio: 1.13). The insurer also had 17%, or $12 billion, of its $71.9 billion assets in goodwill and intangibles. Aetna had a book value of $18.3 billion.
As discussed earlier, Aetna took in $13 billion more debt in preparation for its Humana takeover.
Cash flow
(Aetna cash flow, quarterly filing)
Aetna delivered 67.7% growth to $4.6 billion in its operational cash flow that was mostly brought by increases in health care and insurance liabilities and profit growth. Capital expenditures were $196.9 million leaving the insurer with $4.4 billion in free cash flow.
Aetna has also been known to put most of its cash in investments. Aetna mostly invested its cash in debt and equity securities with an average credit quality rating of A and AAA along with some exposure in below investment grade (rating below BBB-/Baa3). Aetna also has investments in municipal debt securities (9).
Aetna also has investments (
As mentioned earlier, Aetna also took in $12.9 billion in debt nine months into 2016. The $37.7 billion insurer allocated 5.94%, or $262.7 million, in dividends to its shareholders during the period, while no buybacks occurred. Meanwhile, Aetna allocated 54% of its free cash flow for dividends and share buybacks in the past three years on average. Conclusion There seemed to be no stopping Aetna in growing its business despite the challenges it met with the implementation of the Affordable Care Act. Also, Aetna seemed determined to have its Humana deal closed despite government objections. As observed, Aetna allocates most of its cash flow in debt and equity investments. In return, Aetna receives most cash flow from these investments, too, annually (about $11.7 billion, on average, for the past three years). Valuations revealed that Aetna trades at a slight discount to its peers. In April, RBC Capital Markets has Aetna on outperform with a target price of $144. The same firm had an outperform rating on the insurer, but with a $162 per share target back in September 2015. (Aetna Share Price, Google Finance) Using five-year earnings multiple with five-year profit growth rate, along with Aetna's fiscal 2016 earnings-per-share outlook (estimation), I arrived at a $102 per share value. In summary, I would not recommend Aetna until it would go under $100 a share, at least. Notes (1) Morningstar data. (2) GuruFocus data. (3) Quarterly filing: Aetna offers a broad range of traditional, voluntary and consumer-directed health insurance products and related services, including medical, pharmacy, dental, behavioral health, group life and disability plans, and medical management capabilities, Medicaid health care management services, workers' compensation administrative services and health information technology products and services. (4) CNN Money: Aetna will only sell Obamacare products in Delaware, Iowa, Nebraska and Virginia by 2017. (5) Quarterly Filing. Annual Filing: Health Care products consist of medical, pharmacy benefit management services, dental, behavioral health and vision plans offered on both an insured basis and an employer-funded, or administrative services contract, basis and emerging businesses products and services. (6) Quarterly Filing. (7) Annual Filing. (8) Kaiser Permanente: MBRs: For large groups with the minimum amount is 85% of premium revenue. For small groups, individuals and student health plans, the minimum amount is 80% of premium revenue. Insurers who don't meet or exceed these minimum levels are required to issue rebates to customers. (9) Annual filing. Disclosure: I do not have shares in Aetna nor Humana. Start a free seven-day trial of Premium Membership to GuruFocus.
