Humana: Bullish Rating Thanks To Strong Financials And Low Valuation

Analysis Summary

Today I'll be covering Humana (NYSE:HUM), in the healthcare sector, subsector of managed healthcare.

According to its Seeking Alpha profile, it trades on the NYSE, is based in Kentucky, and offers medical and supplemental benefit plans to individuals.

One of its listed peers is HealthEquity (HQY).

This article comes on the heels of another one I did this month covering Cigna (CI), also in the healthcare sector.

In today's article, I gave this stock a buy rating, due to having more strengths in my review than offsetting factors. In fact, it had 6 strengths vs only 1 offsetting factor. This kept it just short of being a strong buy rather than just a buy.

Its strengths include dividends, valuation, revenue YoY growth, net income YoY growth, capital & liquidity, and cheap share price.

Its offsetting factors include its performance vs the S&P500 index.

A downside risk to my bullish outlook is the risk of impact on its income statement from a quarter with much higher claims benefits than usual.

Analysis Methodology

My updated rating methodology as of October 2023 is to analyze the stock holistically across the following 7 categories of equal weight, and if it has more strengths than offsetting factors it gets a buy rating, otherwise will get a hold or sell rating:

dividends, valuation, revenue growth, net income and EPS, capital and liquidity, share price vs moving average, performance vs S&P 500.

All data sources come from publicly available info such as the most recent quarterly report and company presentations, Seeking Alpha data, and media reports.

The anticipated next quarterly earnings release is expected on Nov. 1st for fiscal 2023, Q3. The most recent release reported on Aug. 2nd was for FY2023 Q2.

Dividends

Here I discuss the dividend yield, 10-year dividend growth, and dividend stability over the last few years. As a dividend-focused analyst and investor, I believe these are vital metrics to look at.

Though not all investors are dividend-oriented, including many of my readers, I do think generally speaking it can be a way to generate cash flow while holding an equity longer-term.

First, let's look at the dividend yield, which is 0.73% as of the writing of this article, along with a dividend payout of $0.89 per share, on a quarterly basis.

Whether or not I think it is a good yield depends on how it compares to the industry it is in, and not to other industries.

In comparison to its sector average, this yield is 56.6% below the average. I consider this a moderately negative point as I am looking for a yield between 1% and 3% when considering the sector/industry. With that said, my target for a yield would be 2%, so this stock has a yield that is lower than my goal.

I consider yield important because it tells me a story: how much of a return I am getting on the capital invested, in terms of dividend income. A sudden drop in share price, as you may know, can result in a higher yield if the dividend amount remains the same.

Next, I am looking at the 10-year dividend growth rate, shown in the chart below, which shows a steady growth since 2017. I think that is a positive point and I always look for a good dividend growth story to tell, backed by the data. The story here is one of 5 year steady growth after a dip.

Finally, I want to see dividend payout stability, especially if you are relying on the steady quarterly cash flow.

In looking at the table below, you can see stable payouts over the last few years, with 2 dividend increases in this time period. A cash flow scenario: if I was holding 1,000 shares, for example, I could realize $880 in quarterly cash flow from the dividends on this stock. (1,000 shares x $0.88 per share).

Based on the evidence, I consider the category of dividends a strength for this stock, on the basis of steady dividend payouts and 5 year growth which I think outweighs the below-average yield.

Valuation

To simplify analyzing the valuation, I have chosen a single metric to focus on, and that is the price-to-earnings ratio (P/E), both the trailing and forward P/E, as it tells me what the market is pricing this stock at in relation to its earnings.

My portfolio goal is to find a valuation lower than or close to the sector average, but not too much higher. Sometimes a stock is undervalued but otherwise has strong fundamentals, so that is a company I want to uncover.

In the case of this stock, the trailing P/E is 18.59, which is 33.8% below the sector average, and the forward P/E of 18.37 is 29.1% below the sector average.

Hence, I would consider this stock undervalued compared to its industry, both on a trailing and forward basis.

If you compare its valuation to that of its peer, HealthEquity, that firm's forward P/E is almost 967% higher than the sector, so it is a drastically higher valuation than that of Humana.

Based on the data, I think this valuation metric is a strength for this stock. I want to add my sentiment on why I think it is being undervalued and it seems to correlate with the extended market bearishness on this stock which I will show later in the price chart as well as its performance vs the S&P500. I don't think it is tied to poor profitability since Q2 showed an increase in net income, which I will discuss later.

Revenue Growth

One topic many analysts and investors look at is top-line revenue growth, as a metric tracking revenue generated before expenses, to put it simply.

Manageable growth is important, in my opinion, because companies have competition and are striving to capture market share in their sector.

For this company, we can see from the most recent quarterly results that it achieved a YoY increase in total revenue:

At first glance, I think this is a plus for this company.

In looking further at revenue growth by different business segments, we see that its core business of making money from insurance premiums did well on a YoY basis, as did its interest-earning assets and sale of some of those assets, which collectively helped push the total revenue up.

From my earlier articles covering the insurance sector, we know that a lot of extra cash from premiums is "invested" into fixed-income assets like bonds, and so with the current rate environment it has proven to be a very lucrative tailwind to revenue, and no different for this firm as well.

Overall, I think the data shows that top-line revenue YoY growth is a strength for this stock's rating.

Net Income and EPS

Net income and earnings per share are getting their own section here to make the analysis easier to understand and to separate these results from top-line revenue.

Based on the most recent quarterly results available, and worth mentioning, is that this firm achieved a YoY growth in net income and the basic earnings per share "EPS" increased on a YoY basis.

This is how it looks on their most recent quarterly income statement, which this firm can be proud of I think in terms of profitability, considering they were able to generate a turnaround from their December net loss:

On an adjusted basis, the company also indicated confidence, and according to their CEO Bruce Broussard in his Q2 earnings comments:

The strength of Humana's fundamentals continues to be shown in our results, including delivering second quarter Adjusted EPS of $8.94 and affirmation of our full year 2023 Adjusted EPS guidance of 'at least $28.25.

I think, therefore, that this category of net income and EPS is a strength for this stock's rating.

Capital and Liquidity

Here we'll focus on one or more items related to capital and liquidity strength of this stock's parent company.

One item to call out is the significant improvement to the company cash, compared with the end of 2022:

Further, there is additional data of interest:

From its cash flow statement we can see that the firm has positive free cash flow in the form of $3.2B in levered free cash flow and $3.29B in unlevered free cash flow, along with $23.38 in free cash flow per share.

From its balance sheet, the company ended Q2 with $16.2B in cash, $56.4B in total assets, and $39.5B in total liabilities, leaving $16.8B in positive equity.

In addition, I think it's important to mention that this company is active in share repurchases this year, which is a sign that it commits to return capital to shareholders and has the capacity to do so:

I think that the equity along with the cash flow definitely adds confidence to this stock's rating, backed up by strong company financial health.

Some time ago I received a comment from a reader that they had never seen an insurance company with "negative" equity. That may or may not be accurate, and so far the ones I covered on this platform have always been positive equity, but I am sure I will come across a company eventually that is essentially "underwater" with negative equity, and that is one investment I generally try to avoid if possible.

Based on the evidence found, I consider this firm's capital and liquidity situation a strength to its overall rating.

Share Price vs. Moving Average

Now we've come to the part where I like to talk about the share price and whether I think it's a buying opportunity right now or not.

First, let's take a look at the share price and 200-day moving average as of the writing of this article:

The share price of $498.17 is 1.6% above the 200-day SMA which stands at $490.06. I think this moving average is a good long-term trend indicator which is why I track it.

In my portfolio goal, I am looking for crossover opportunities, where the price crosses below the moving average after a period of bullishness, which I consider a buy signal as long as other fundamentals are strong. However, a buying opportunity could also exist if the price is hovering around the moving average.

This chart shows a slight crossover already occurred recently, followed by a slight rebound, so to test the share price against my portfolio goals I created the following simulated trade scenario. I buy 100 shares at the current price, hold 1 year, and want to achieve at least a 10% or better (unrealized) capital gain at that time.

In addition, in anticipation of losses as well, I have set my maximum loss tolerance as -20% (unrealized capital loss).

The above simulation shows two scenarios, one where the future share price rises +15% above the current 200-day SMA, and the other where it drops -15% below the SMA.

The outcome of both scenarios is that they are in line with my goals for gains and losses. For example, in scenario A I am projecting a gain of 13.1%, while in scenario B I am projecting a loss of -16.3%.

Based on this simulation, I think the current share price is a strength.

Though your portfolio strategy may differ, consider this section a general and simplified framework with which to think about this stock in a longer-term sense, in which time one can expect potential gains as well as losses, so establishing a maximum risk tolerance is important.

Performance vs. S&P 500

The following is a comparison of the 1-year price performance of this stock vs the S&P 500 index. I have included this metric in my updated rating methodology so as to compare this equity to a major market index that is tracked often, and whether it was able to outperform it or not.

I consider this relevant because it shows the market momentum for this stock. It may be a great company fundamentally, but the market reality is that other investors influence the share price based on demand for the stock, so comparing it to this major index could add some clues as to market sentiment.

The data shows the stock underperforming vs this index for an extended period ever since last year, which I consider an offsetting factor to my rating, as I believe it to indicate a lukewarm market sentiment for this stock.

If you correlate the above performance with this stock's YCharts I showed earlier, it appears that late spring and summer was the period when the market was most bearish on this stock.

Risk to my Outlook

A downside risk to my bullish outlook would be unique to the type of business that Humana is in, and that is the impact on its income statement if Q3 and Q4 see higher than average claims benefits payouts.

Consider that for the first 6 months of 2023, the company already faced a 13% increase in benefits expenses.

If Q3 and Q4 continue to see spikes in benefit expenses, the headwind to profitability may cause investors and analysts to feel bearish on this stock.

However, my counterargument to that is that this firm has such a strong cash position as well as positive cash flow, which I showed earlier, that I believe it should be able to withstand such shocks and this is something to be expected in the insurance industry, the risk of certain months or seasons seeing higher than usual benefits claims.

In closing, my bullish sentiment on this stock remains and my buy rating stands.

Incidentally, a fun fact is that this happens to be one of those articles where I am essentially agreeing with the consensus of a "buy" as shown below, with both analysts as well as Wall Street and the quant system showing a Buy.