Summary:
- CNC has revised its FY24 guidance, targeting an adjusted EPS of over $6.60, compared to the previous guidance of $7.15.
- I believe the downward revision was necessary to reset expectations given the challenges faced by the company, including Medicaid margin impacts, Medicare Advantage rate changes, and other factors.
- With a significant percentage of its Medicare Advantage lives enrolled in plans rated 3 Stars or below, CNC’s focus on achieving a 3.5-Star rating is a priority.
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Description
In late February this year, I recommended a neutral rating for Centene Corp (NYSE:CNC) which turns out to be right as the stock declined further by another 10+% before recovering. I also discussed about how Centene Corp FY24 EPS guidance was too hard to achieve given all the possible headwinds, which seems right given the revision in guidance. With the new FY24 guidance, I believe investors’ expectations have reset expectations and sentiment should improve going forward. Importantly, I suspect management is taking this opportunity to sandbag FY24 numbers, so they can pull a beat and raise later, as the guide seems to reflect a mismatch between acuity and rates in Medicaid. Also, if the MA Stars improvement does better than expected, it is not impossible to see CNC beating this guide. However, just to be conservative, I am sticking to my recommendation of a hold rating until I see CNC executing as planned, and is on track to meet this FY24 guide.
New guidance
As anticipated, CNC has revised its FY24 guidance due to various factors that impacted its Medicaid margins, Medicare Advantage [MA] rates, and overall business investments. The company now targets an adjusted EPS of over $6.60 in 2024, compared to the previous guidance of $7.15. It is worth noting that this new EPS guidance falls below prior consensus expectations, leading to the consideration that the revised guidance may be conservative. The revision in guidance stems from a higher Medicaid Health Benefits Ratio [HBR], increased investment in MA, and several other challenges such as lower Medicare membership, lower Star scores, redeterminations, and additional investments. However, I expect these headwinds to be partially offset by strong growth in the Marketplace segment, savings from pharmacy benefit management [PBM] contracts, and optimization of operating expenses. In my perspective, the downward revision in guidance was necessary to reset expectations given the visible challenges. This adjustment represents a positive step forward. However, the focus now shifts to whether CNC can meet this revised guidance and whether the underlying assumptions are too optimistic or conservative. For example, in Medicaid, the guidance incorporates a 50-basis point headwind to the 2024 Medicaid HBR, considering potential delays in state rate adjustments relative to shifts in the risk pool. The full impact of acuity shifts and the pace of state rate reactions will only become evident as we progress further into redeterminations. Overall, I believe the guidance revision was a necessary and inevitable step. Now, the management should direct their efforts towards meeting this guidance and demonstrate progress in every earnings report leading up to 2024. Monitoring the company’s ability to navigate the challenges and achieve the revised targets will be crucial in assessing the accuracy of the guidance and the company’s performance.
Redeterminations
Medicaid HBR is expected to reach 89.8% in 2023 and 90.1% in 2024, according to the new guide. This estimate incorporates the 50bps increase from redeterminations, which will be partially offset by the benefit from the new PBM contract. Notably, management has built a -50bps provision into HBR to cover the possibility of a delay between state rate adjustments and the arrival of patient populations with a higher degree of medical complexity. The continued presence of a sicker population within the Medicaid rolls worries me because it could lead to a temporary margin headwind if premium increases do not keep pace with the rise in average medical expenses per member. Redetermined members are generally predicted to have lower utilization rates, so the potential disconnect on rates has been a source of concern. This dynamic is also one of the key reasons why I believe management might be conservative with numbers, as this headwind (fundamentally a timing issue) might not be as big as expected.
Medicare Advantage
Given that roughly 80% of its MA lives are enrolled in plans rated 3 Stars or below at present, I believe CNC’s focus on achieving a 3.5-Star rating going forward is the right priority. I think the shift makes a lot of sense, as the difference between the bid and the benchmark is refunded at 65% for contracts rated 3.5 stars or higher and 50% for plans rated 3 stars or lower. By emphasizing the monetary rewards that come with higher Star ratings, this incentive structure encourages CNC to work toward those goals. Second, if you’re working with a population that has underserved and/or complex members, it will be harder to earn a coveted 4-Star rating. That said, differences in Stars ratings between standard MA policies and those serving a disproportionately large number of members from low-income or otherwise complicated backgrounds will be eliminated in 2027 with the introduction of a health equity index. With the health equity index in place, CNC may be able to close the Stars gap for these contracts and earn a coveted 4-star rating. To put it simply, I think that encouraging CNC members to switch to contracts rated 3.5 stars or higher will lead to positive growth for the company. This tactical attention also opens up possibilities for speeding up the member transition even further. With the changing membership composition and potential rule changes associated with the Health Equity index adjustment, management is revising its multi-year target, previously set at 60% for 4+ Star plans.
Marketplace
In the first few months of 2023, CNC’s membership growth significantly outpaced expectations. This encouraging change has had a major impact on the business’s risk pools. As a result of these redeterminations, I believe healthier members will either switch to the exchanges or choose employer-sponsored coverage, both of which will contribute to the growth of the Marketplace. In fact, management has restated its prior guide that between 200,000 and 300,000 lives will be added during the redetermination time frame.
Summary
My recommendation for CNC remains a hold rating until I see the company executing as planned and on track to meet its FY24 guidance. I suspect that the revised FY24 EPS guidance might be too conservative, and we could see beat and raise scenario if headwinds and self-inflicted provisions do not turn out to be as bad. However, all these cannot be verified and ascertained today, as such, the best move is to simply wait and monitor results in my view.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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