Medicare And Medicaid Expansion With AI Integration Set To Boost Revenue And Margins

Key Takeaways

• Enhanced member growth in Medicare and Medicaid, along with cost management strategies, indicates potential for increased revenue and improved net margins.
  
• Investments in automation and strategic partnerships, particularly with Google for AI, aim to reduce operational costs and improve efficiency, positively impacting net margins.
  
• Ongoing medical cost pressure from higher inpatient costs and challenges with the two-midnight rule might impact profitability and growth expectations despite countermeasures.

Catalysts

Provides medical and specialty insurance products in the United States.

• The expected continued growth in Medicare business and raised forecast for member growth indicate potential to increase revenues, potentially impacting future revenue growth positively.
  
• Implementation of strategies to mitigate medical cost pressure, such as ensuring clinical appropriateness of admissions and enhancing claims audits, signals improved net margins through cost management efforts.
  
• Anticipation of growth through both contract wins and member growth in Medicaid, combined with expectations of mitigating modest claims pressure, suggests possible positive impacts on future earnings through expansion in Medicaid business.
  
• Investments in automation and partnerships, such as the one with Google to accelerate AI efforts, indicate potential reduction in administrative and operational costs, positively affecting net margins by lowering cost to serve.
  
• The initiative to enhance digital enrollment experience and improve logistics in specialty pharmacy facilities highlights efforts towards efficiency and effectiveness, potentially leading to lower distribution and operational costs, thereby positively affecting net margins.

Assumptions

• Analysts are assuming Humana's revenue will grow by 5.0% annually over the next 3 years.
• Analysts assume that profit margins will increase from 1.5% today to 2.5% in 3 years time.
• Analysts expect earnings to reach $3.2 billion (and earnings per share of $28.64) by about September 2027, up from $1.7 billion today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as $2.6 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 16.0x on those 2027 earnings, down from 25.2x today. This future PE is lower than the current PE for the US Healthcare industry at 26.6x.
• Analysts expect the number of shares outstanding to decline by 2.83% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 5.82%, as per the Simply Wall St company report.

Risks

• Higher inpatient costs have emerged, particularly in the second quarter and continued into July, indicating ongoing medical cost pressure that could challenge future margins.
  
• The company is facing challenges in responding to the implementation of the two-midnight rule, leading to higher-than-anticipated inpatient admissions and potentially impacting medical loss ratios (MLR).
  
• Efforts to mitigate inpatient cost pressures through appropriateness checks and negotiations with provider partners may not fully offset the heightened costs, suggesting potential risk to profitability.
  
• The reliance on favorable risk scores and Medicare Advantage (MA) membership growth as counterbalances to inpatient cost pressures assumes these positive factors will continue, which may not be guaranteed, impacting revenue projections.
  
• The strategic exits from certain MA plans due to unprofitability indicate a potential reduction in membership and revenue, which could impact overall growth expectations and margin recovery in the near term.

Valuation

• The analysts have a consensus price target of $393.73 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 $473.0, and the most bearish reporting a price target of just $349.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $129.8 billion, earnings will come to $3.2 billion, and it would be trading on a PE ratio of 16.0x, assuming you use a discount rate of 5.8%.
• Given the current share price of $357.86, the analyst's price target of $393.73 is 9.1% 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.