We are maintaining our BUY rating on Humana Inc. (NYSE: HUM), reflecting the company’s strong growth in the Medicare Advantage market. This market is expanding rapidly as aging Americans seek secure medical and insurance benefits during retirement. The U.S. Census Bureau has estimated that the number of U.S. residents over 65 will double over the next four decades, with one in five residents over the age of 65 by 2030. In addition to its MA business, Humana is expanding its Health Care Services segment to gain share in noninsurance markets. Our revised target price is $450, raised from $430.
Demographic trends in the U.S. are favorable for the growth of Humana’s Medicare Advantage (MA) business. The number of Americans age 65 and over will increase to more than 220 million by 2025, up from about 150 million in 2010, according to the U.S. Census Bureau. Moreover, by 2025, more than 175 million Americans will be coping with at least one chronic condition, such as diabetes or cardiovascular disease.
Medicare Advantage is available to older people and other adults with qualifying disabilities. These plans are offered by private insurers, including Humana, instead of the federal government. In addition to Part A hospital and Part B medical coverage, MA plans typically include Part D prescription drug coverage. Some plans may also cover vision, dental, and hearing expenses. Importantly, MA insurers have financial incentives to aggressively manage chronic conditions and the everyday health of members. Such management can improve outcomes and lower the total cost of care.
Humana experienced solid enrollment trends in 2020. Its individual MA membership grew 10% to 3,935,100. Its group MA membership grew 17% to 612,000.
On November 3, the company reported 3Q20 adjusted EPS of $3.08, down from $5.03 a year earlier. GAAP net income was $1.340 billion or $10.05 per share, compared to $689 million or $5.14 per share a year earlier. The 3Q GAAP results reflected one-time nonoperational items, including a gain from publicly traded investments and the receipt of unpaid risk-corridor payments that had been previously written off. Total revenue was $20.1 billion (+23.6%), compared to $16.2 billion a year earlier. Adjusted revenue, which excludes the two non-operational items, was $18.8 billion (+15.9%).
The medical loss ratio (MLR) was 82.6% (-240 basis points) on a GAAP basis and 85.3% (+30 basis points) on an adjusted basis. Medical utilization continues rebound from the March-April 2020 trough. By the end of 3Q20, utilization had reached about 95% of historic baseline levels. Utilization rose at a faster pace for the fully insured group commercial segment, compared to a more gradual recovery for senior and Medicaid members.
Despite the near-term rise in utilization, however, we see strong growth drivers for Humana.
EARNINGS & GROWTH ANALYSIS
The company provided updated guidance for 2020. It now expects adjusted EPS of $18.50-$18.75. For 4Q20, it expects a net loss of $2.55 per share due to rising utilization and the cost of COVID-19 crisis relief efforts.
The company has raised its guidance for membership growth in its individual Medicare Advantage segment. It now expects full-year 2020 growth of approximately 375,000 members, compared to a prior view of 330,000-360,000. Based on the updated guidance, we are raising our adjusted EPS estimates to $18.55 from $18.40 for 2020 and to $21.80 from $21.60 for 2021.
Our five-year EPS growth rate forecast is 11%.
FINANCIAL STRENGTH & DIVIDEND
Our financial strength rating on Humana is Medium-High, the second-highest rank on our five-point scale. The company pays an annualized dividend of $2.50, for a yield of about 0.6%. Our dividend estimates are $2.50 for 2020 and $2.70 for 2021.
Humana faces risks if medical costs rise faster than the actuarial projections that are used to set premiums. Costs that rise more quickly than expected would pressure profit margins.
Humana faces competitive risks in both the commercial and government markets as rival insurers, both for-profit and not-for-profit, seek to expand share.
The federal government is also seeking to rein in rising Medicare costs, and its efforts in this area could hurt Humana’s ability to grow and sustain margins in its Medicare Advantage business.
Humana is a health benefits company that offers coordinated health insurance coverage and related services through a variety of plans for retirees, employer groups, and government-sponsored programs, such as Medicare Advantage and Medicaid. Humana serves more than 14 million medical members in fully insured and ASO (administrative services only) plans. The company also has a Health Care services segment that offers, among other things, PBM services, home care services, and primary care services.
HUM shares trade at 18.8-times our 2021 EPS estimate, above the average of 16.8 for peer stocks in our managed care coverage universe. We believe Humana’s strong growth drivers support this valuation. We are reaffirming our BUY rating with a revised price target of $450.
On January 5, BUY-rated HUM traded at $413.18, up $0.99.