Firm Profile: Anthem Inc., is a health benefits company based out of Indiana in the United States. The company has approximately 40 MM plan members across large and small employers, individuals, Medicaid and senior markets. The company provides full health care plans, as well as hybrid plans such as hospital only and limited benefits, insurance products for dental, vision, life and disability, along with a range of managed care services to self-funded customers such as claims processing, provider network access and other administrative services. Furthermore, Anthem also provides services to the federal government through the federal employee program and the medicare program. Anthem is a leader in most of the 14 states it operates in under the Blue Cross and Blue Shield Association.

Industry: Healthcare

Sub-sector: Healthcare Facilities and Services

Rating: BBB

Macroeconomic Backdrop: Recent economic data continues to indicate a growing trend towards a global slowdown that is being exacerbated by the trade war and Trump’s Twitter tantrums. This is evidenced in the latest US GDP print where the manufacturing sector showed significant slowdown, while the economy was buoyed by a strong US consumer with consumer spending up by 4%. CEOs are happy to remain on the sidelines and wait and watch how the tariff tensions play out before making business investment decisions and this negative sentiment will continue to be a drag on the economy until a trade deal is reached. The overall US economy however, is not in bad shape, given that 70% of the economic activity is driven by the consumer and while inflation remains below target, the labor market continues to be strong. The case of an insurance cut was undermined by the GDP print and the “mid-cycle adjustment” isn’t likely to help address any of the slowdown concerns. Despite, Powell’s indication that this isn’t the start of a rate cutting cycle, the FED historically is never one and done. Furthermore, a single 25 bps point cut in today’s economy at a time when we have seen unprecedented levels of fiscal stimulus, is far more likely to cause financial market dislocations that spur any real economic growth. There is no alternative to following the data and given the bias towards slowdown, now would be a prudent time to allocate to higher quality names in the defensive sectors.

Industry Outlook: Of the three predominant defensive sectors, healthcare is the preferred choice as valuations in both consumer staples and utilities look expensive when compared with their historical P/E ratios. From a credit perspective, healthcare companies’ balance sheets remain solid and cost structures are reasonable but the real story is one of increasing demand. Strong demographic forces resulting in an ageing population should continue to fuel demand for healthcare services going forward. Furthermore, with the US election year coming up, the rhetoric over ‘medicare for all’ is bound to ramp up. Whether that materializes or not is a different story but it is likely to produce volatility for the sector, creating opportunities for investors.

Fundamental Analysis: The most recent Q219 results show that operating revenues increased to US$ 25.2 B which is a 10.8% YOY growth. Much of this growth came through organic channels, namely membership growth and annual premium increases. The cost structure continues to be stable and in line with industry trends.

The balance sheet remains strong and cash flow generation continues to be healthy, leading to improving interest coverage ratios. At the end of the second quarter, Anthem had US$ 4.1 B in cash against US$ 19.3 B of long-term debt. Total debt to capital was at 39.7%, which is in line with Management’s long-term target.

Positive Catalysts: IngenioRX is the recently launched pharmacy benefits management (PBM) company of Anthem. PBMs are essentially the middlemen between pharmacy companies and the end customers and by bringing this function in house, Anthem is now able to provide its members with both healthcare and pharmacy benefits which is likely to fuel future revenue growth. It is also expected to lower costs as Anthem was previously contracting out the pharmacy benefits service. The significant drugs cost savings from IngenioRX are expected to be largely passed on to clients. In the most recent earnings call, Management increased the long-term EPS CAGR to 12-15% on top of the benefits that are expected from IngenioRX. Including IngenioRX will accelerate this growth rate to the high double digits.

In addition, Anthem has a strong reputation in the government segment of their business. This should serve them tremendously well and Management is confident that they will get their fair share of the US$ 80 B pipeline of Medicaid opportunities over the next 5 years.

Risks: A recent headwind for Anthem has been the eligibility re-verification done by a couple of states which has resulted in some healthier members dropping out and has left Anthem with a less healthy or risker pool relative to the premiums charged. However, this should be a short-term headwind, as mid-year and end-year premium adjustments are expected to be made to reflect the higher risks.

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