Molina Healthcare: Medicaid Redetermination, Buying Opportunity (NYSE:MOH)

We are recommending shares of managed care firm Molina Healthcare (“Molina”) (NYSE:MOH). The stock has fallen ~15% for the reason that begin of 2022, largely over considerations concerning the affect of redetermination on the corporate’s Medicaid membership. The stock at latest costs represents a beautiful alternative to accumulate shares.

Molina has grown EPS yearly since 2010 at 24.3% each year. The firm seems to be on a path to develop its EPS at a mid-teens price for the following 3 to five years. Over the final 10 years, the stock has produced 24.7% annualized returns and outperformed the S&P 500 and the S&P 500 Healthcare Sector.

Molina’s stock appears to have a positive danger/reward profile at present costs. The stock has potential upside of 20-50% over the following 12 to 18 months and the potential for 15+% annualized returns over the following 3 to five years. The stock’s draw back within the near-term appears restricted to fifteen% in case you apply a Centene (CNC) a number of to Molina’s embedded EPS.

Given that the stock has underperformed the market this 12 months and is down roughly 20% from its 52-week excessive of $374, we imagine that the market has largely priced within the redetermination dangers. Even if administration is optimistic of their estimated affect Medicaid redetermination, the potential incremental hit to EPS would solely be $0.60 to $0.80, or a couple of 3% to 4% hit to 2023 core EPS estimates.

Molina has a protracted development runway. Healthcare prices are rising, and the corporate is taking materials market share from the bigger insurers. Molina has simply 5.25 million members (versus friends with 25 to 50+ million members) and is just current in a choose variety of territories throughout the U.S. Molina’s has grown its members by 16.4% each year over the previous 3 years and expanded into a number of new territories, notably Los Angeles County California.

The firm’s give attention to Medicaid leads to a extra recession resistant enterprise mannequin than different well being insurers as a result of managed Medicaid membership tends to develop when unemployment charges rise. The unemployment price within the U.S. presently stands at 3.5% and is probably going heading greater, which ought to result in extra folks turning into eligible for Medicaid.

MOH is buying and selling at 13.5x our blended ahead (BF) 12-month EPS estimate and 10.4x our estimate of the corporate’s embedded earnings energy. These multiples are properly beneath the corporate’s 10-year common P/E of roughly 17.8x. EPS ought to develop at a mid-teens % annualized price for at the very least the following 3 years, which is in keeping with historic development charges beneath the present CEO.

Background

Molina Healthcare is a managed care firm that primarily focuses on offering Medicaid insurance coverage to people within the U.S. The firm generated $32 billion of income from its ~5.25 million members in 2022. Molina operates in 18 states throughout the U.S. with no state making up greater than 20% of revenues.

History

Emergency room doctor David Molina based Molina Healthcare in 1980 in Long Beach, California. Dr. Molina arrange his first main care clinic with the aim of treating the lowest-income sufferers no matter whether or not they had been in a position to pay. Dr. Molina ran the corporate till he died in 1996, at which level his sons J. Mario Molina and John Molina took over the operations.

Mario and his youthful brother John took the corporate public in 2003 and remained in cost till 2015. From the stock’s IPO via the center of 2015, MOH was among the finest performing managed care corporations, producing 17.2% annualized returns. However, in 2016 and 2017, the corporate’s working bills spiraled uncontrolled and EPS plummeted. The poor monetary efficiency resulted in Mario and John’s removing from their positions.

After a six-month search, the Board of Directors employed the corporate’s present CEO Joseph Zubretsky. Zubretsky is a 35-year insurance coverage and monetary companies business veteran. Perhaps Zubretsky’s most related expertise was the 9 years he labored as an Executive Vice President at Aetna from 2007 till 2016. Zubretsky ran Aetna’s National Business which was Aetna’s flagship enterprise unit with $10 billion in revenues.

Business Turnaround

Zubretsky centered on turning across the firm throughout the early months of his tenure. Within the primary 6 months on the job, he reduce out $235 million of promoting, common, and administrative bills (SG&A), strengthened the corporate’s stability sheet via taking the correct reserves, realigned administration incentive applications to give attention to earnings fairly than premium development, and introduced in 4 new senior executives. The mixed impact of those adjustments restored Molina’s margins to a aggressive and sustainable degree.

Zubretsky believed that if he might institute price self-discipline throughout the firm, he might then pivot to a development plan that may generate important shareholder worth. Just one 12 months after Zubretsky took over, Molina’s stock was up 75%. Adjusted EPS went from being destructive in 4 out of the prior 5 quarters to at least one quarter of EPS exceeding any single 12 months of EPS since MOH’s IPO in 2003. Zubretsky’s plan was clearly working, and in 2019, he shifted the corporate’s focus in the direction of development.

Molina is now on observe to ship mid-teens premium income development over the long run. Most of the expansion will come from the corporate’s Medicaid enterprise. Management believes the corporate can develop 8% to 10% organically via new membership, greater premiums, and enlargement into new markets. Simultaneously, acquisitions of smaller regional insurers will present extra development upside of 5%.

Key Investment Opportunities

Market Share Gains Drive Organic Growth

Molina’s presence in simply 20 states leaves the corporate with runway for 8% to 10% natural top-line development over the following 5 to 10 years. The firm has simply 4.75 million Medicaid members, which represents solely 5% market share. MOH’s main publicly traded competitor Centene is greater than 3 instances bigger with ~16 million Medicaid members and a presence in 38 states, which suggests the corporate has considerably extra territory to defend. Centene’s administration sees their Medicaid enterprise rising at a 6% to 7% CAGR long-term. That is 2 to three proportion factors decrease than the speed at which Molina’s administration believes they will develop.

Every couple of years, states undergo a re-procurement course of the place they are going to put out a request for proposal (“RFP”). Managed care suppliers then submit bids providing Medicaid companies within the state. Since Molina’s footprint represents simply half of the 41 states with managed Medicaid, the corporate has a big addressable market to go after in terms of responding to RFPs.

Management has succeeded in profitable new enterprise via state re-procurements. During 2022, the corporate doubled the scale of its enterprise in California by profitable a serious contract in LA county away from Centene. Molina additionally expanded into Iowa and Nebraska, whereas renewing its contract in Mississippi.

Management indicated on the fourth quarter 2022 convention name that their RFP pipeline is robust.

“Our acquisition pipeline remains replete with actionable opportunities. While the timing of transactions remains difficult to predict, the strength of our pipeline and our track record of success gives us confidence in our ability to drive further growth from this important element of our growth strategy.”

-Molina Fourth Quarter 2022 Earnings Call Transcript

The firm is searching for to additional increase into New Mexico and Florida within the close to time period. Additionally, there are a number of states which might be anticipated to place out RFPs over the approaching years. Management’s historic execution provides us confidence that Molina will proceed to win new contracts.

Defensive Business Model

Managed Medicaid, which represents 90% of Molina’s membership, tends to be an economically defensive enterprise mannequin. During weak financial instances when unemployment rises, Medicaid enrollment tends to extend. If managed correctly, greater membership sometimes results in greater premium revenues and better earnings.

As the Fed continues to lift charges to battle inflation and plenty of main financial indicators proceed to flash purple, the possibilities of a U.S. recession and thus a weakening of the labor market within the U.S. appears to be rising. A weaker economic system would usually be good for Molina’s enterprise.

Given Molina’s natural development alternatives, MOH is a little bit of a win-win scenario for macro-concerned buyers. Since the corporate has a number of development alternatives, it’s prone to proceed to develop whether or not the economic system is in good or dangerous form.

There’s proof that the corporate can nonetheless do properly even in a powerful economic system with declining Medicaid membership. For instance, when Medicaid enrollment declined between 2017 and 2019, Molina’s EPS in 2018 and 2019 nonetheless grew.

On the opposite hand, if the economic system turns south and unemployment rises, that ought to result in an increase in Medicaid eligibility, which suggests Molina will develop membership, which in flip results in greater premium revenues and excessive earnings.

While EPS did decline year-over-year in 2020, this was largely as a result of states tried to retrospectively recoup money paid to managed care suppliers that was not spent on advantages throughout Covid. These actions resulted in a one-time hit to EPS in 4Q22 of $2.14. Excluding this one-time hit, EPS would have grown 10.7% to $12.81 in 2020 versus 2019.

Significant Embedded Earnings Power

Since Molina started implementing its development technique, the corporate has made acquisitions and gained quite a few state Medicaid contracts. The profit to the underside line from these actions usually takes just a few years to be realized. The delayed advantages usually come within the type of one-time implementation prices in addition to what Molina refers to as a “new store” part. The “new store” part contains earnings which might be anticipated to be realized from attaining goal margins on acquisitions in addition to new Medicaid contract wins.

Between 2020 and 2022, Molina accomplished ~$1.0 billion in acquisitions. Deals of observe embody the corporate’s $850 million acquisition of Magellan Complete Care in December 2020, the $176 million acquisition of Affinity Health Plan in October 2021, and the $150mm acquisition of My Choice Wisconsin, which is predicted to shut in mid-2023.

These tuck-in offers rapidly turned accretive as Molina’s administration group implements their working technique to spice up profitability by reducing prices and rising membership. Once these offers are absolutely carried out, they’re anticipated to present an extra $4.50 per share in EPS over the following 1 to three years.

On January 3^rd of this 12 months, Molina introduced that the California Department of Health Care Services (“DHCS”) confirmed its beforehand awarded contracts to Molina. DHCS granted Molina a contract to offer companies in Riverside, Sacramento, San Bernardino, and San Diego Counties and as a subcontractor in Los Angeles County. The contract is predicted to start January 1^st, 2024, and to develop Molina’s California membership from 600 thousand to 1.2 million. Annual premium income from Medi-Cal is predicted to greater than double from $1.9 billion to $3.9 billion.

The win in California is massive and getting ready for its new members would require one-time implementation prices. Management has quantified these prices at $0.75 per share and these numbers are included within the 2023 steerage of $20.25 per share. Excluding these one-time prices, Molina’s embedded earnings energy in 2023 is roughly $21 per share, which means that the stock is buying and selling at simply 13.6x EPS at latest costs.

One ultimate issue that’s suppressing Molina’s earnings is the non permanent implementation of danger corridors in response to the Covid-19 Pandemic. According to administration, these Covid danger corridors negatively affect EPS by roughly $2.00 per share. Below is the excerpt from the corporate’s 2023 10-Okay explaining the affect of the corridors on the monetary statements.

Beginning in 2020, varied states enacted non permanent danger corridors in response to the lowered demand for medical companies stemming from COVID-19, which resulted in a discount of our medical margin. The present price atmosphere is steady and rational. We proceed to imagine that the risk-sharing corridors beforehand launched are associated to the declared PHE and can possible be eradicated because the COVID pandemic subsides. However, the danger corridors proceed to contribute an added degree of variability to our outcomes of operations. We acknowledged roughly $197 million [of additional expense] for the affect of danger corridors within the 12 months ended December 21, 2022, in comparison with $323 million acknowledged within the 12 months ended December 31, 2021. The lower in 2022 is because of the elimination of many of the COVID-19 danger corridors.

-Molina Healthcare 2023 Form 10-K

Risk corridors have been eradicated throughout the nation, so the elevated bills from this coverage are anticipated to abate in 2023.

The mixture of Molina’s acquisitions, new contract wins, the one-time California win implementation prices, and the Covid danger corridors lead to future extra earnings of $7.25. Assuming the Covid danger hall prices go away in 2023 or 2024, the California implementation prices are a one-time hit to 2023 EPS, and the “new store” part of Molina’s acquisitions and new contract wins fall into earnings over the following 2-3 years, the corporate is properly on observe to develop EPS to $27.50+ within the subsequent 2 to three years. This quantity assumes zero natural development, i.e., additional new contract wins and membership development.

At $27.50 in embedded earnings, Molina’s stock is buying and selling at simply 10.4x earnings.

Buyout Potential

At a $15.3 billion market cap, Molina is 1 / 4 of the scale of its subsequent largest competitor Centene. This leaves the potential for Molina to be a beautiful acquisition goal. MOH has comparatively enticing margins given how a lot smaller the corporate is versus its friends, so there’s possible some stable room for synergies.

The more than likely purchaser of Molina might be Cigna (CI) given the strategic overlap. Cigna has little or no Medicaid enterprise and a big business market enterprise. The defensiveness of Molina’s Medicaid enterprise would assist scale back Cigna’s sensitivity to financial cycles.

Mr. Zubretsky is 65 years outdated and owns $87 million of equity in MOH. We wouldn’t be shocked if he determined to hunt to promote the corporate and retire in 3 to five years.

Redetermination Risk Seems Priced In

Redetermination is presently the forefront of buyers’ considerations. In 2020, Congress enacted the Families First Coronavirus Response Act (FFCRA). In trade for enhanced federal funding, the FFCRA required Medicaid applications maintain folks enrolled via the top of the month wherein the COVID-19 public well being emergency (PHE) ends. The steady enrollment provision was an essential contributor to the ~28% enhance in Medicaid enrollment between February 2020 and October 2022.

The enhance in Medicare enrollment has benefited Molina. The firm’s Medicaid membership between the primary quarter of 2020 and the top of 2022 grew 60% to over 4.7 million members. Not all this enhance was the results of the continual enrollment provision, however Molina definitely benefited.

In December of 2022, Congress handed a invoice that ended the continual enrollment provision on March 31, 2023. The passing of this invoice coincides with the underperformance of Molina’s stock value this 12 months. A robust economic system does pose a possible draw back danger on condition that wages have elevated considerably, and employment is robust. A robust economic system tends to coincide with a decline in Medicaid enrollment.

However, it appears greater than possible at this level the redetermination dangers have been priced into the stock.

Molina’s administration group has communicated to the funding group that embedded in 2023 steerage is roughly a $533 million destructive affect from the resumption of redeterminations that may started to happen in 2023. On the primary quarter 2023 earnings convention name, administration additional outlined their expectations,

Within our steerage, our outlook on the resumption of redeterminations and the affect on our enterprise is unchanged. Through March closing. We estimate we gained roughly 800,000 members organically for the reason that begin of the pandemic. We proceed to count on to retain roughly half of the members gained. We count on the premium affect to be roughly $1.6 billion. And that portfolio common margins. The earnings affect to be roughly $1 per share. Due to the timing of when members dis enrolled, we’re projecting one-third the premium and earnings affect to emerge in 2023. With the rest largely in 2024.

-Mark Keim, CFO, Molina First Quarter 2023 Earnings Call Transcript

If we assume an after-tax margin of three.5%, the hit to EPS is $0.97 over the course of two years. Using administration’s $533 million steerage for 2023, that’s roughly a $0.32 hit to EPS. This quantity has already been accounted for in administration’s FY 2023 steerage of at the very least $20.25 per share.

Running a sensitivity analysis on this affect reveals that even when administration is off of their $1.6 billion estimate by $1 billion (~65%) and we assume these are greater margin revenues, the whole affect to EPS over the course of 24 months is simply $1.84. Applying a historic common a number of of 17.3x to this affect worst case situation affect implies a $31.80 hit to Molina’s stock.

Again, Congress’s resolution to finish the continual enrollment resolution on the finish of 2022 is what sparked the decline this 12 months. Molina’s stock began the 12 months at $330, so at most the penalty to the stock ought to be to $300 in case you select to disregard all the opposite potential upside contributors.

Molina’s administration group is notoriously analytical with their projections, and so they are likely to beat earnings estimates too. It is secure to say we’d be dumbfounded if their estimates had been off by 60%. The numbers present that the redetermination dangers have been greater than priced into the stock at this level.

Key Investment Risks

Medical Cost Trends

Medical loss ratios (“MLR”) are traditionally a big mover of managed care corporations. It isn’t unusual to see a medical health insurance firm beat on income and EPS however nonetheless fall 5% to 10% as a result of their MLR was greater than what buyers had been in search of.

MLR ratios are nearly not possible to foretell as a result of so many components can weigh on medical health insurance utilization. For instance, a nasty flu season could ship extra folks to the hospital, which leads to greater healthcare utilization. While over the long-term Molina ought to usually be capable of preserve 87% to 89% MLR ratios, any kind of occasion which will trigger the corporate’s MLR to spike might lead to volatility for the stock.

Legislation / Regulation

While any adversarial laws is unlikely within the near-term, new laws are all the time at the back of buyers’ minds in terms of investing in healthcare corporations. For instance, throughout 2018 and main as much as the 2020 election, the concept of Medicare For All considerably impacted well being insurers with massive market companies. More just lately, rhetoric from congress surrounding pharmacy profit managers (“PBMs”) and their affect on drug costs has harm the shares of managed care corporations with important PBM companies (CI, ELV, CVS) are all down considerably over the previous few months.

In common, extra regulation in healthcare has typically benefitted the most important gamers. However, healthcare buyers are notoriously finicky. We’ve seen the affect of Congress’s resolution to finish the continual enrollment provision on the stock. Molina has roughly 7% hedge fund possession as properly. Hedge funds are typically quick money shareholders.

Model

Below is a abstract model of our working mannequin. We are projecting a 9.6% income CAGR via 2025 and margin enchancment as the corporate scales and integrates acquisitions. Margin enchancment leads to EPS development exceeding income development.

Comps

The finest publicly traded comp for Molina is Centene, which is de facto the one different managed care firm that primarily focuses on Medicaid. While Centene does solely trade at 10.2x EPS, the corporate has been going through challenges. Centene has been the topic of regulatory scrutiny, authorized disputes, operational points, and aggressive pressures. Their overly aggressive acquisition program has led to some dis-synergies and missed earnings expectations.

The firm simply appointed 5 new board members and introduced in a wholly new administration group over the past 12 months. Given the turmoil, Centene lacks the market share acquire alternative that we imagine Molina has. Similar to Molina, Centene has considerably de-rated over the previous few months.

As for the opposite managed care suppliers, these corporations give attention to market and/or Managed Medicare. Managed Medicare is a secular development story. UNH and Humana are the most important suppliers of managed Medicare within the nation, which leads to their shares buying and selling at excessive teenagers P/E multiples. The different market centered gamers trade within the low double-digit to mid-teens P/E multiples.

Valuation & Return Forecast

Molina has traditionally traded at a P/E ratio of between 13x and 20x. The stock often has traded as little as 9x and as excessive at 25x. The stock’s common P/E over the past 10 years is 17.8x, whereas its median is 17.2x.

Absolute draw back might be ~$245 or ~15%. In our draw back calculation, we embody the $7.25 in embedded earnings from one-time California implementation prices, “new store” EPS from latest acquisitions, and the elimination of Covid danger corridors (see rationalization above). The math implies the draw back on the stock is ~12x our BF12M EPS estimate of $20.55.

Longer-term, we apply a 15x a number of, in keeping with Centene’s long-term median P/E ratio. Given the expansion profile, market share potential and business main ROEs, we predict 15x is a conservative a number of. This additionally represents a ten% low cost to the S&P 500’s 10-year median P/E ratio of 17x.

At 15x in 2-3 years we see the chance for ~14.6% annualized returns.

Conclusion

Molina’s stock at latest costs represents a compelling entry level and affords the potential for long run market beating features. Every couple of years it appears affected person buyers are in a position to choose up shares of stable healthcare corporations because the markets give attention to short-term points and ignore the longer-term story. The same scenario provided enticing entry factors for Cigna and Elevance Health (ELV) in 2018 and 2019, when fears over Medicare For All had been at their absolute most. While Cigna and Elevance Health had been unstable shares for a number of quarters and appeared like lifeless money, persistence was rewarded.

The defensive nature of Molina’s managed Medicaid enterprise together with the sturdy natural development profile make Molina a stable identify to personal throughout a recession. If the Fed continues to maintain its bias in the direction of excessive charges, a recession is an actual risk, leading to sturdy membership development for Molina and capital flows into the stock.

Editor’s Note: This article was submitted as a part of Seeking Alpha’s Best Investment Idea For A Potential Recession competitors, which runs via April 28. This competitors is open to all customers and contributors; click on right here to seek out out extra and submit your article at this time!