David Einhorn’s 2 New Buys in Managed Care Sector

By Gayatri Sharma - August 2, 2012 | Tickers: CI, CVH, GMCR | 0 Comments

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David Einhorn has been in the limelight ever since he made his famous bearish presentation on Green Mountain Coffee Roasters (NASDAQ: GMCR) last year. GMCR has plummeted ~80% since he presented his short thesis, and those who followed his advice made quite a bit of money. I follow David Einhorn’s portfolio activities closely trying to catch his next big move. I recently scanned his July 23, 2012 investor newsletter for ideas and his new positions in the managed care sector were particularly interesting. In his own words:

“The Partnerships established several substantial new positions in the managed care sector, including Cigna (NYSE: CI) and Coventry Health Care (NYSE: CVH). The entire sector had been battered in anticipation of Obamacare. For the most part, these companies have unlevered balance sheets and trade at single-digit P/E multiples on earnings that should continue to grow. They have no exposure to the European currency crisis, a possible Chinese slowdown or other cyclical headwinds. While the stocks are already cheap, there is the additional unpriced upside in the possibility that the election changes the political landscape, resulting in a possible modification or repeal of Obamacare”.

Here’s a look at Cigna and Coventry Health Care in detail.

Cigna is currently trading at a forward PE of just 6.80x. According to consensus estimates, the company’s top line is expected to grow 30.10% in the current year and 8.70% next year. Its EPS estimate for the current year is $5.51 and is $6.09 for the next year. I like the company’s exposure to higher growth international and medicare segments. 25% of the company's earnings now come from these segments. In addition, the company’s VADBe liabilities are steadily moderating and a potential VADBe divestiture may be another catalyst for the stock.

I believe the company’s earnings should re-accelerate in 2013 on medicare and international growth. The medicare segment should, in particular, benefit from the HealthSpring acquisition. Although the acquisition was only modestly accretive for 2012, it can add ~6% to 2013 earnings. Also, the international segment of earnings should re-accelerate after a flattish 2012 due to accounting recognition changes. Consensus is expecting ~11% YoY EPS growth. Clearly, a 6.8x multiple is too low for the company. In addition, the company’s VADBe liability continues to decline and the number of outstanding VADBe contracts continues to moderate at 480k, down 40% over the last five years.

Cigna is currently trading at ~$42, which is significantly lower than David Einhorn’s purchase price of $45.42. Hence, you can buy the stock even cheaper than David Einhorn, and I recommend it as a strong buy.

Coventry Health Care is available at a slightly higher price than the $31.22 average price which David Einhorn paid for it. I like Coventry as well, albeit to somewhat lesser degree than Cigna. Coventry’s stock is facing some headwinds from a recently-acquired three-year contract to provide managed care services to the Medicaid population in Kentucky. This caused the company to significantly reduce earnings guidance for 2012 and resulted in a significant share price drop. However, at a recent investor event, the company provided a positive update on the Kentucky Medicaid contract. The company has received notice of a 5.3% rate increase in Kentucky that will take effect October 1, in addition to positive corrections to the current reimbursement. This will help the company to alleviate some of the cost pressures that have been weighing on profitability. In addition, Coventry’s aggressive share repurchases also makes me positive on the stock.  CVH repurchased 6.8 million shares during 2Q, lowering the diluted share count to 135 million. I expect the company to continue returning cash to the shareholders in the near future. At 10x forward PE, the stock valuations looks attractive given its expected 18% EPS growth rate from the current year (FY2012) to the next (FY2013).

To sum up, managed healthcare sector presents some attractive investment opportunities in current times. Cigna in particular stands out because of its high EPS growth prospects from its medicare and international segments, and its low valuations. Coventry also looks good, as the headwinds from Kentucky Medicaid contract are receding and it is buying back shares aggressively.

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