Near-Term Uncertainty Creates Opportunities in Managed-Care Shares

Near-term uncertainty is creating an opportunity for long-term investors in the managed-care organization segment. Of the six narrow-moat MCO stocks that we cover—Centene CNC, Cigna CI, CVS Health CVS, Elevance ELV, Humana HUM, and UnitedHealth UNH—five are trading in undervalued territory, and even the typically premium-priced UnitedHealth looks reasonably valued to us.

There are some near-term headwinds that the industry faces, which we think will be manageable in the long run. First, renewed Medicaid redetermination activities are probably going to cut into the Medicaid population during 2023-24, which could decelerate the industry’s top-line growth prospects somewhat. However, the MCO strongholds of employer-sponsored and individual plans look likely to act as safety nets to offset about three quarters of expected Medicaid losses, which could provide cover on the bottom line as those businesses tend to be more profitable than Medicaid plans. Also, Medicare Advantage plan growth looks set to decelerate a bit due to recent moves by the Biden administration. But this end market looks likely to lead the medical insurance market’s growth for the foreseeable future, especially as Medicare Advantage’s popularity continues to increase versus traditional Medicare due to the extra benefits that older adults can receive in the former versus the latter. Additionally, the pharmacy benefit managers are coming under regulatory scrutiny for their lack of transparency, especially in variable compensation methods; even if those methods must change we expect the PBMs to switch most clients over to fee-based arrangements. Last, election cycles can create headwinds for MCO shares, but if mixed control of the federal government continues, the MCOs will likely continue to enjoy a relatively benign policy environment, which will give them more time to expand beyond the heavily regulated medical insurance business into less regulated and potentially higher-margin businesses, such as caregiving services.