Industry: Health Insurance
Changing U.S. demography with baby boomers entering retirement age in hordes has pushed up demand for products such as Medicaid and Medicare. This has led to strong membership growth with states turning to private players to manage these plans.
Also, development of ancillary business in recent years to diversify revenue sources, in the wake of tough regulations laid on the health insurance business, has opened up new avenues of growth. These businesses, mostly in the form of health care services, are growing rapidly and forming a large part of the industry's total revenues.
Companies attach great importance to health services business, which enables them to play a role of a comprehensive health care provider and thus have made huge investments for expansion. Therefore growth in this business should continue, thus providing resilience to the industry's top line.
Despite revenue growth, medical cost increases and laws relating to minimum medical loss ratios have put pressure on the bottom line. Moreover, a shift in business mix in recent years from Commercial full risk to the less-profitable administrative services only, has partially offset the otherwise strong revenue growth.
Nonetheless, better claims handling, medical cost management, technological investment and upgrade, application of blockchain technology, mergers and acquisitions, and healthy balance sheets should help health insurers stand tall going forward.
Outstanding Industry Returns
Imposition of tough regulations from the Affordable Care Act and the subsequent regulatory uncertainty brought in by the Trump's administration did not deter the industry's growth. In fact, the health insurance industry has put up a good show and gained from an increase in insured rates, which have directly led to an increase in revenues, membership and earnings of the players in the industry. Strong capital levels across the industry have enable disciplined capital management via share buyback and dividend payments, which have further drawn investor attention.
The Zacks Medial-Health Maintenance Organization industry, which is a stock group within the broader Zacks Medical Sector, has outperformed both the S&P 500 and its own sector over the past year.
Health Insurance Stocks Look Attractive
The industry's outperformance over the last year explains to some extent its high steep valuation. We look at the industry's price-to-earnings ratio (PE) ratio, the most appropriate ratio for valuing a health insurer as its earnings stability.
The PE ratio essentially measures the company's share price relative to its earnings. It tells how much an investor should pay for per unit of the company's earnings.
The industry currently has a forward 12-month P/E ratio of 17.6, which is at its median level over the preceding year. In the past year, the industry has traded in a range of 15.9 to 20.1.
The space looks a bit stretched when compared with the market at large as the trailing 12-month P/E ratio for the S&P 500 is 16.7.
However, going a step further and considering the industry's growth rate, which is reflected by its PEG ratio, we find the industry attractively valued. Its forward 12-month PEG ratio of 1.3 compares favorably with that of 1.7 for the S&P 500. This indicated the industry's superior growth potential and an attractive valuation.
Outperformance May Continue Despite Soft Earnings Outlook
Increasing demand for retirement products from the aging U.S. population should lead to an increase in Medicaid and Medicare products, which should aid the top line. Moreover, increasing employment will also drive employers' demand for insurance for their employees. The formation of Accountable Care Organizations (ACOs) - a group of health care providers aimed at providing efficient care at lower cost - should help to keep a check on medical care cost, thus aiding margins.
But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. The earlier valuation discussion shows that market participants have been willing to pay up for these stocks already, potentially limiting further upside from the current levels.
One reliable measure that can help investors understand the industry's prospects for a solid price performance going forward is its earnings outlook. Empirical research shows that earnings outlook for the industry, a reflection of the earnings revision trend for the constituent companies, has a direct bearing on its stock market performance.
The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations from it and the aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.
Price and Consensus: Medical HMO Industry
This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.
Please note that the $10.98 EPS estimate for the industry for 2018 is not the actual bottom-up EPS estimate for every company within the Zacks Life Insurance industry but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the industry's earnings for 2018 but how this estimate has evolved recently.
While the consensus earnings estimate for the Zacks Foreign Banks industry of $10.98 per share implies a decent year-over-year improvement (up 15.2%), the trend in earnings estimate revisions has not been favorable lately.
Looking at the aggregate earnings estimate revisions, it appears that analysts are losing confidence in this group's earnings potential.
The consensus EPS estimate for the current fiscal year has been revised 0.8% downward since May 31, 2018.
Zacks Industry Rank Indicates Improvement
The group's Zacks Industry Rank is basically the average of the Zacks Rank of all-member stocks.
The Zacks Life Insurance Industry currently carries a Zacks Industry Rank #93, placing it at the top 36% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Health Insurers Promise Long-Term Growth
The long-term prospects for the industry are bright. When compared with the broader Zacks S&P 500 composite, the long-term (3-5 years) EPS growth estimate for the Zacks Health Insurance industry appears promising.
Though the group's mean estimate of long-term EPS growth rate has moderated a tad since January 2018, when it was 13.29%, to reach the current level of 13.13%, the same compares favorably with 9.8% for the Zacks S&P 500 composite.
Mean Estimate of Long-Term EPS Growth Rate
In fact, the basis of this long-term EPS growth could be a steady top line that the Zacks Health Insurance industry has sustained since 2010.
Continuing consolidation in the industry should transform health insurers into comprehensive health care providers, which will enable the companies to offer superior care at lower cost thus aiding margins.
Recently the Department of Labor released the final rule on Association Health Plans for small businesses across the United States, which is expected to benefit approximately 11 million citizens of America, working for such firms. This would also lead to higher demand for health insurance plans.
Also, development of products and services, which include care delivery, population health management and engagement, health financial services, health IT, benefit operations, care operations and pharmacy care services, which complement their core business lines - Commercial, Medicare and Medicaid products - and enable enhanced service delivery and experience to their customers and will accrue to revenues and earnings.
In recent years, health insurers have been moving to international markets. This shift is expected to continue given that the international markets remain underpenetrated. This should provide immense scope for growth.
Therefore keeping the long-term projections in mind, investors could take advantage of the attractive valuation and bet on a few health insurance stocks with a strong earnings outlook.
Below are four stocks with positive earnings estimate revisions and a bullish Zacks Rank.
WellCare Health Plans, Inc. is the provider of managed care services for government-sponsored health care programs.
The company is based out of Tampa, FL and sports a Zacks Rank #1. The expected earnings growth rate for the current year is 20.53%. The Zacks Consensus Estimate for the current year has improved 4.6% over the last 60 days. The stock has gained 37% in a year's time.
Molina Healthcare, Inc. is a provider of government sponsored plans - Medicare and Medicaid The stock carries a Zacks Rank #1 (Strong Buy). The expected earnings growth rate for the current year is 725%. The Zacks Consensus Estimate for the current year has improved 25% over the last 60 days. The stock has gained 42% in a year's time.
Humana Inc. is a provider of retail, group and specialty healthcare insurance services.
The company is based out of Louisville, KY and carries a Zacks Rank #2 (Buy). The expected earnings growth rate for the current year is 19.47%. The Zacks Consensus Estimate for the current year has improved 0.8% over the last 60 days. The stock has gained 24% in a year's time.
Anthem, Inc. is the owner and operator of a health benefits company in the United States. It provides commercial, business as well as group health insurance plans.
The company is based out of Indianapolis, IN and has a Zacks Rank #2. The expected earnings growth rate for the current year is 27.78%. The Zacks Consensus Estimate for the current year has improved 1.9% over the last 60 days. The stock has gained 28% in a year's time.
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