Optimizing Operations And Focusing On Profitable Segments Will Drive Sustainable Long-Term Value

Key Takeaways

• Strategic membership mix adjustment and clinical excellence focus are driving sustainable value, improved revenue, and net margin profitability.
  
• Operating efficiency improvements and strategic expansion in primary care and Medicaid indicate balanced long-term earnings growth potential.
  
• Humana's profitability is threatened by regulatory challenges, Medicare Advantage uncertainties, drug cost pressures, and the need for high Stars ratings.

Catalysts

Provides medical and specialty insurance products in the United States.

• Humana is focusing on shedding unprofitable plans and resetting expectations with lower margin plans. This strategic membership mix adjustment is expected to drive sustainable long-term value and improve revenue from more profitable segments.
  
• The company is enhancing clinical excellence by closing care gaps, which improved Stars' performance metrics. This focus on better clinical outcomes reduces system costs and improves product profitability, positively impacting net margins.
  
• Humana achieved a 40 basis point improvement in the operating expense ratio by optimizing care models, unifying shipping activities, outsourcing noncore capabilities, and streamlining distribution. This increased operational efficiency should enhance net margins.
  
• The expansion of Humana's primary care footprint and organic Medicaid growth are central to its strategy. Prioritizing margin recovery while continuing to grow earnings capacity reflects a balanced approach to long-term earnings growth.
  
• Investment in new management and technology, particularly in using data and digital tools for customer engagement, suggests future revenue growth as Humana enhances its product experience and customer retention strategies.

Humana Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Humana's revenue will grow by 5.2% annually over the next 3 years.
• Analysts assume that profit margins will increase from 1.0% today to 1.7% in 3 years time.
• Analysts expect earnings to reach $2.4 billion (and earnings per share of $20.14) by about March 2028, up from $1.2 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $3.3 billion in earnings, and the most bearish expecting $2.0 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 18.1x on those 2028 earnings, down from 27.0x today. This future PE is lower than the current PE for the US Healthcare industry at 23.9x.
• Analysts expect the number of shares outstanding to grow by 0.12% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.41%, as per the Simply Wall St company report.

Humana Future Earnings Per Share Growth

Risks

• Humana faces significant regulatory and external headwinds, which could impact its ability to deliver consistent financial performance and shareholder value. This may affect net margins and earnings.
  
• The company needs to maintain a competitive Stars rating to achieve a 3% margin in its Medicare Advantage (MA) segment, and any failure to do so could adversely affect revenue and profit margins.
  
• Medicare Advantage funding uncertainties, especially around future rates that may not fully account for expected medical trends, could adversely impact revenue and net income.
  
• There is potential risk in group MA margin improvement due to historical long-term rate guarantees, which places near-term pressure on profitability and net margins.
  
• The complexity and fragmentation of the U.S. healthcare system, along with pressures from specialty drug costs, could result in increased operating costs, impacting earnings and profit margins.

Valuation

• The analysts have a consensus price target of $297.641 for Humana based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $424.1, and the most bearish reporting a price target of just $241.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $136.9 billion, earnings will come to $2.4 billion, and it would be trading on a PE ratio of 18.1x, assuming you use a discount rate of 6.4%.
• Given the current share price of $269.78, the analyst price target of $297.64 is 9.4% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.