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Is WellPoint Healthy for your Portfolio?
Related Stocks:
WLP, UNH12/07/2007:
As we rapidly approach the 2008 Presidential Elections, one political issue has reignited debate – health care. A topic sure to be a critical factor in this next election will be how the candidates plan to insure America’s 46.6 million citizens without medical insurance.
To examine this topic, I performed an in-depth study of the largest health insurer by membership, Indianapolis-based WellPoint, Inc (WLP).
Company Overview
WellPoint was formed in 2004 by the merger of WellPoint Health Networks Inc. and Anthem Inc. It is currently by membership the largest provider of health care plans in the United States, with over 34 million members as of December 31, 2006. Its 2006 annual revenue of $57 billion was only surpassed by UnitedHealth with $71 billion in revenue.
As the Blue Cross Blue Shield Association licensee in 14 states, the company has one of most the recognized marketing brand names and provider network in the health insurance industry. Earlier this year, the company instated a new CEO, Angela Braly. The company has also announced plans to restructure its internal operations into three separate business units, commercial, consumer, and a comprehensive solutions unit for health care providers.
Valuation Based on Organic Growth
To determine the impact of the Presidential proposals on the health care industry, and in particular WellPoint stock, I built a discounted cash flow (DCF) model for WellPoint. As a control comparison, I ran a default set of assumptions through the model.
This initial scenario assumed that WellPoint grows organically through 2011. Revenue growth projections for each of WellPoint’s businesses were obtained from the sell side research analysts at CIBC World Markets. I based profit margins on recent historical financial data.
After running the model several times, it decided on a current valuation of 88.50. Clearly, even at today’s stock price the model indicates that WellPoint stock may be slightly undervalued.
Valuation with Presidential Proposals
After the initial runs of my DCF model, I factored in the impact of Hillary Clinton’s proposal should it be enacted into law. Hillary’s proposal is by far the most ambitious of presidential candidates by making health insurance mandatory for all citizens, much like auto insurance.
Surprisingly, adding Hillary Clinton’s proposal to the valuation model had little impact on WellPoint’s stock price. Despite assuming WellPoint achieves a 10% market share of the uninsured, the model only added about 2.00 per share to the stock.
I attribute this to rather conservative estimates. Hillary’s plan assumes that the 44.6 million uninsured can be covered for about $110 billion, or $195 per member per month (PMPM). Compared to commercial plans of about $260 PMPM, Hillary’s plan seems to offer limited coverage. The model also assumed an 85% medical loss ratio (MLR) on the added revenue.
Looking at the Republican plans, I doubt that they would carry great change for the health care industry. Candidates including Giuliani advocate large income tax deductions to make Health Savings Accounts (HSA’s) more attractive. Such plans provide little additional revenue to companies like WellPoint and would have virtually no impact on the uninsured.
Government Spotlight is Good, but…
While increasing attention from political candidates may be good for the health care industry, it does carry caveats. As politicians hope to insure more of the population and keep premiums low, there is a temptation to impose legislation limiting the profit margins of health insurers.
One such example is California’s proposed insurance plan, which sets an 85% MLR. If such a strain on profit margins were nationally imposed, it would be a back-breaker for many companies like WellPoint. Hillary Clinton supports MLR quotas, but so far has not specified details. I suggest eyeing the political proposals with caution as we approach the 2008 Election and beyond.
Mortgage Market Contamination?
It should be noted that WellPoint has invested $5.5 billion in mortgage-backed securities (MBS), $300 million of which are subprime loans. These are the nasty securities that have wreaked havoc on investors and Wall Street this past year. I feel that an impairment of WellPoint’s MBS holdings is likely.
Although WellPoint’s investment income comprises a small portion of revenue, a write-down of the MBS assets will disrupt asset liquidity and can negatively impact shareholder-friendly initiatives such as the stock buyback program.
Final Thoughts
Given the recent rally of WellPoint’s stock price, I feel neutral about this company as a portfolio holding. While the long term outlook seems positive, it is tainted by the possibility of increasing government regulation and mortgage investments.
For a more in-depth look at my WellPoint DCF model and a full research report, you may download them at the following links:
WellPoint DCF Model
WellPoint Full Equity Research Report
Full Disclosure: At the time of this writing, Winston does not hold positions in WellPoint or UnitedHealth.
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