Humana's Fall Creates A Rare dip Buying Opportunity

Investors are facing one of the rarest cases in financial markets, where a deeply entrenched enterprise operating in one of the most 'defensive' sectors has left a pain trail following a 15.3% decline over the past couple of days. Humana NYSE: HUM investors were spooked after learning that the company's medical cost ratio has risen, as senior citizens are playing catch up on surgeries and other costly - insurance covered - procedures.

As every industry carries its own set of key performance indicators (KPIs), the medical cost ratio can be a leading indicator of potential profits and losses for the health insurance industry.  

Despite a severe drop in the stock price, Humana is not alone in this very issue affecting the current investor sentiment towards the name. Peers like UnitedHealth Group NYSE: UNH and Molina Healthcare NYSE: MOH have also experienced similar sell-offs at the time data was released. UnitedHealth saw a decline of 9.5% during the same period, with Molina falling by as much as 7.4%.

With Humana seeing the most aggressive drop in the group, investors have a reasonable cause for concern. Humana's valuation multiples, however, are now the lowest in the peer group and thus providing a rare buying opportunity for investors who understand that this is not a company-specific issue. 

Assessing "Damage"

It is a typically cyclical aspect of the healthcare industry, as psychological 'herd' behavior may be at play as a growing population of similar-age citizens shares in the decision to finalize overdue procedures. Investors can begin to turn their focus away from the noise brought on by market sentiment and the panicky headlines regarding these industry indicators and begin to assess what Street analysts and management insiders are saying about the company's future potential.

After the company's first quarter 2023 earnings results, the picture will become a bit clearer.

Investors will notice a significant improvement across the board within the earnings press release, with revenues growing by 11.5% to outpace inflationary concerns and successfully managing debt levels, which declined to 41.1% from 45.8% a year prior. Operating cost ratios declined to 11.2% from 12% a year prior.

Most importantly, management deployed significant amounts of capital toward the company's share repurchase program throughout the year. Buying back 134 thousand shares during 2022 at an average price of $495.68 per share aided the delivery of an outstanding 35.3% annual growth in the earnings per share rate, which closed the first quarter of 2023 at $9.91 per basic share. 

Since management kept $2.8 billion aside for further share repurchases during 2023, investors are in for significant insider support. As management bought the majority of shares at an average price of $495.68, today's prices reflect a nearly 8% discount from where insiders thought the stock to be relatively cheap.

Within the report, management also provides optimistic guidance for the remainder of the year and ambitious targets for 2025. Expected 2023 earnings per share will rise "at least" toward $27.88, with an even more bullish target of $37.0 per share for 2025. Is management looking to pivot current sentiment by allowing these assumptions, or is there a base for these targets?

The Real View

Humana analyst rating points a different viewpoint, as consensus targets signal a near 31% upside scenario from today's prices and a further top-side price target of $652 to provide a potential 43% ceiling room in the stock. As the current inflation rate in the United States begins to decline, as the FED's implementation of a 15-month rate hike trajectory takes effect, medical costs - despite increased procedures - should be offset by a further increase in premiums charged.

As the year-on-year 11.5% revenue bump was enough to account for at least two years of inflation, alongside positive management expectations, investors should virtually have nothing to fear.

Perhaps one unorthodox leading indicator investors can look for to time some 'real' issues brewing inside Humana is the price spread against Medical Properties Trust NYSE: MPW. Historically speaking, when Humana underperforms Medical Properties for at least two quarters, it typically signifies a double-edged sword event. 2019, for example, Humana underperformed Medical Properties for the whole year, as earnings per share halved during the fourth quarter of 2018.

These events were driven by similar trends, rising input costs in medical care and procedures, which inversely benefitted Medical Properties, as hospitals in the portfolio brought increased cash flows.