It’s hard for investors to remember 15 months ago, when private health insurers experienced an oversized drawdown in stock prices. Wall Street was fixated on the elimination of private health insurance under a nationalized Medicare plan pushed by then poll-leading, Democratic candidate for President, Bernie Sanders.
I wrote a story explaining the growing worry that insurance companies could be forced out of business and supplanted by a national health system for payments if Democrats gained the levers of power in Washington, DC. At the very least, insurers may have to compete with lower-cost government options, aligned with Medicare, for consumers and businesses. Despite the growing reality of a serious change to the health insurance marketplace approaching fast, investors in the major insurance providers still appear relatively unconcerned. Stock prices have recovered their large 2019 declines, and the mainstream press has moved on to bigger problems for the U.S. economy. How quickly investors forget.
Honestly, the political picture for private health insurers remains quite bleak starting in 2021. If you believe the polls (I do), candidate Joe Biden’s election victory in November is less than 99 days away. He was one of the main architects of the Obamacare changes to our health insurance marketplace in 2010. In addition, the odds of Democrats taking both houses of Congress are better than 50/50 as I write this article. The Democratic platform in coming weeks will surely include language about increased government participation in the health care industry to reduce overall costs (profits for private insurers) and expand coverage for more Americans.
While I am on board with the altruistic goals of giving everyone fair access to health care services at reduced expense, changing our system of payment will be a huge blow to private insurers, including Cigna (CI). From my perch, analysts and prognosticators today are completely ignoring the odds of a stark profitless reality for private health insurers starting in 2021-22. Overly bullish and optimistic takes on Cigna are everywhere, modeling little or no changes to the U.S. health industry course in coming months.
Chuck Walston, whom I personally rank as one of the top minds on Seeking Alpha, wrote a great bullish piece on Cigna last month. His arguments and research are thorough and well-explained. Long-term demographic shifts and the COVID-19 changes in operations affecting Cigna are worthwhile considerations. That’s what management has planned for, and has been forced to deal with this year. If Trump wins reelection and Republicans keep the Senate, Cigna’s future may be very bright.
Below is a table of the bullish SA writer positioning and Wall Street analyst ratings of Cigna just months before the election. Notice the divergence in optimism between analysts/authors and the computer-driven Quant score of profit returns/margins, growth rates, valuations, and technical trading action.
Image Source: Seeking Alpha Ratings July 25th, 2020
Too Much Leverage
However, few on Wall Street are modeling massive changes to Cigna’s business model are just around the corner. If Biden and the Democrats sweep to power, private health care insurance operations will undoubtedly look different than July 2020 in rapid fashion. What should worry investors in Cigna specifically is its over-leveraged position going into a potential downshift in operating profits.
At the end of 2018, Cigna acquired Express Scripts, a pharmacy benefits manager. The merged company idea was the insurance provider could provide customers and subscribers with a more integrated drug delivery proposition. Instead of relying on your local pharmacy for filling prescriptions, Cigna would directly send you pharmacy product through the mail. It sounds great on paper, and should work fabulously for both customers and Cigna if health care system rules are not altered.
The good news for Cigna stakeholders is earnings per share are expected to expand nicely from the Express acquisition, assuming the playing rules stay the same (i.e., Biden or Trump do not introduce major tweaks to the health care service world in 2021). And given projected numbers are hit, the stock quote looks like a solid buy proposition. Below is a graph of currently anticipated, above-average growth rates for Cigna’s bottom line by Wall Street consensus.
The strong expected income future for Cigna is a function of its extensive, low-cost financial leverage in the merger. Yet, while leverage helps the bottom line under optimistic trend scenarios, it cuts both ways if results instead come under pressure next year. I can easily model earnings turning into losses from either a steeper-than-anticipated coronavirus recession (as health insurance payouts for medical care climb) or serious headwinds caused by federally mandated health insurance price-fixing. The worst-case outlooks would be private insurers are relegated to secondary status for extra coverage beyond government-provided options, or a push to make private insurance illegal altogether finds enough votes in DC (Bernie’s plan).
The Scripts deal moved Cigna’s debt and leverage into the stratosphere. Below are 5-year charts of the night and day change in its balance sheet and margins/returns investors in the stock must gulp and swallow. Debt-to-equity and debt-to-asset calculations are up about 150% since 2018. Profit margins are about half of the early 2018 high.
Net after-tax profit margins and cash flow-to-assets are near the bottom of its peer and competitor group in the diversified health care and insurance grouping. Below, you can review 5-year comparison graphs of Cigna skating near the edge of substantial trouble going into 2021 vs. UnitedHealth Group (UNH), Anthem (ANTM), Humana (HUM), HCA Healthcare (HCA), Universal Health Services (UHS), CVS Health-Aetna (CVS) and Walgreens Boots Alliance (WBA).
The company is deeply in the hole for net assets, with a negative tangible book value of -$36 billion. In other words, if business results fall appreciably in 2021-22, no real backstop for the equity valuation exists today. It would take an estimated seven years of earnings (at the same rate as 2019-20) just to get back to an even setting of zero tangible book value.
Cigna does not pay much of a dividend to shareholders either. Below is a graph of the yield on its $0.04 per share yearly payout. Basically, the company has little tangible asset backing or worth based on shareholder cash payouts.
At the end of March, Cigna owned $31 billion in current assets like cash and accounts receivable. It held $52 billion in debt and contracted insurance liabilities, with $109 billion in total liabilities. Using my favorite apples to apples comparison, the company’s $78 billion net long-term debt and IOU total ($109 billion – $31 billion in current assets) is a monster sum against just $8.2 billion in trailing 12-month cash flow from operations. Today’s 9.5x ratio vs. the S&P 500 company average closer to 5.5x on trailing results is very extended and risky for shareholders. In theory, it would take almost a decade of constant rate cash flow to pay off all net long-term liabilities, slashing any reinvestment into the business! What if cash flow and earnings are set to fall off a cliff next year?
Any way you calculate Cigna’s balance sheet position, tremendous leverage, potentially right before the rules of operation are changed by Uncle Sam, should have investors quaking in their boots. The operating company is not prepared, in any fashion, for a sharp downturn in sales and income. The “risk” part of the equation in Cigna shares is uniquely and overridingly high, in my estimation.
Technical Trading Weakness
Cigna scores in the bottom 5% of S&P 500 companies in my computer sorts of momentum the last month. I am not the only one looking at the stock and wondering about its long-term future. Sellers do exist in large numbers, despite analyst optimism. Below is a chart of the -23% underperformance of Cigna shares vs. the S&P 500 price change the last 18 months, circled in green.
The Negative Volume Index (NVI) numbers highlight significant selling and overhead supply since January. A measure of trading activity only on lower volume days vs. the previous session, the big slide in the NVI is telling us sellers have been willing to dump shares on slow news days. The fact that the NVI is at a yearly low last week, despite a stock quote in the middle of its range the last 12-18 months, is not a good sign, technically speaking. The red arrow marks the NVI on my chart.
On Balance Volume (OBV) stats have also been sliding since February. OBV outlined a 9-month low last week, and is looking less healthy as time passes. Marked with the blue arrow, OBV is a basic record of buying/selling price changes at the close multiplied by volume. While not a perfect predictive indicator by itself, using it alongside other momentum signals helps to dissect differences in large computer sorts.
Lastly, Cigna’s price is below both its simple 50-day and 200-day moving averages. For chartists, the 50-day looks ready to decline beneath the longer-term creation this week. Such a move is often considered exceptionally bearish, commonly referred to as the death cross. The last instance of today’s formation technically was February 2019, just before the stock slid 25% over eight weeks of trading, marked with purple circles.
Change is a constant in our world. Political upheaval in America could create a 180-degree change in the direction of private health insurance company fortunes. Failing to understand this change may be quite costly for Cigna investors, in particular. Management can only do so much to prepare for price controls, rationing, and other mandated government drags to the business model. And a potential business-ending move to nationalize insurance offerings still cannot be ruled out in 1-2 years.
Few analysts are modeling massive headwinds to Cigna’s operations, now increasingly likely to begin in 6-12 months. Debt/leverage are sky-high, and the dividend is all but nonexistent. Excessive leverage at the wrong time in the business development cycle could produce a huge burden for Cigna months from now. Essentially, the company’s setup has little room for error in management execution.
In the end, the upside story in Cigna may prove more of an illusion in the real world. A Biden/Democratic sweep of U.S. government control could generate massive headaches and losses for the private health insurance industry, and Cigna in particular. The reward potential is not worth the major inherent risks to its business model setup. I rate the shares a Sell or Avoid in July 2020.
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Disclosure: I am/we are short CI. 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.
Additional disclosure: This writing is for informational purposes only. All opinions expressed herein are not investment recommendations, and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity and is not a registered investment advisor. The author recommends investors consult a qualified investment advisor before making any trade. This article is not an investment research report, but an opinion written at a point in time. The author’s opinions expressed herein address only a small cross-section of data related to an investment in securities mentioned. Any analysis presented is based on incomplete information, and is limited in scope and accuracy. The information and data in this article are obtained from sources believed to be reliable, but their accuracy and completeness are not guaranteed. Any and all opinions, estimates, and conclusions are based on the author’s best judgment at the time of publication, and are subject to change without notice. Past performance is no guarantee of future returns.