Centene Corporation

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 3/5

Centene Corporation is a multinational healthcare company that primarily provides a variety of managed care services to individuals under Medicaid, Medicare, and other government-sponsored programs.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview:

Centene Corporation (CNC) is a diversified healthcare enterprise focusing on government-sponsored healthcare programs. They primarily operate in the Medicaid and Medicare markets, serving millions of members across various states. They are also involved in the Health Insurance Marketplace, which allows individuals and families to purchase health plans, and a variety of other health care services.

Revenues: CNC generates revenue through premiums from its health plans, and service revenue from providing healthcare management, such as specialty pharmacy, vision, dental, and behavioral health services. These revenues are influenced by membership numbers, premium rates set by state and federal governments, and the breadth of service offerings. As we will discuss later, government funding is a huge part of the revenue and a huge risk for the company.
Industry Trends: The healthcare industry is facing challenges with rising costs, increased focus on care quality and outcomes, and a growing need for specialized and coordinated services. Technology adoption, including telehealth, data analytics, and artificial intelligence, is rapidly changing the healthcare landscape. Further, the demand for Medicaid and Medicare programs is increasing as an aging population coupled with lower income populations. The political and regulatory landscape around healthcare is increasingly intense and complex.
Margins: Profit margins are influenced by medical costs (including utilization trends, medical expenses, pharmacy costs), administrative costs, competition, pricing dynamics, reimbursement policies set by governments, and economies of scale. The S&A expenses are a big component of the costs for them. In recent years, the margins have been under pressure because of higher medical and administrative expenses. The operating expenses and earnings may show drastic fluctuations due to changing policies and requirements. This is one of the biggest factors for the volatility of the business. Also, a great deal of their cost, medical claims liability, are based on estimates, and thus, may not always materialize with accuracy, causing more problems.
Competitive Landscape: The managed care industry is highly competitive, featuring numerous large and small players such as UnitedHealth, Anthem, and CVS Health. The industry has consolidated significantly over the years, creating very large, powerful players. Competition revolves around premiums, network strength, service offerings, geographic expansion, and relationships with government entities. All the big companies offer similar offerings, and thus, pricing pressure is high. Scale is especially important in winning contracts. Also, for winning the government contracts, political connections and influence is also important, as we will see below. In a market where price is very important, the lowest bidder wins and profits are hard to guarantee.
What Makes CNC Different? CNC’s business model is more focused on government-sponsored programs, which has allowed them to grow faster and be more concentrated. The company has also implemented technology for value-based services and to make the workflows efficient. They focus on a differentiated strategy by focusing on underserved populations.
Other Relevant Aspects: The biggest risk for CNC and other similar companies is regulation risk. Since a huge part of the revenue comes from government spending, the profitability of the company is heavily determined by the government and their policies. The regulatory hurdles also make for a big barrier of entry.

Financials Deep Dive:

Recent Financial Performance: From their latest financials, CNC has shown mixed results. The company has increased its membership by a large amount in the last years, however, its profit has been volatile. The company continues to face pressures from rising health care costs, increased competition, and new regulations. Recent revenue and earnings show a decline.
Revenues: They earn from premiums from insurance contracts they offer, other services revenue, and government contracts revenue. Total revenue was $121.6 billion in 2023, a YoY growth of 7.2%, which is a very good number, showing that the company can grow. However, the growth has mainly been from membership increases and some of the revenue growth was from higher-than-average premiums, and thus, they may not be sustainable. Also, since government contracts are a big source of their revenue, they face the risk of unfavorable changes in government policy. In 2023 they lost around a million members in their Medicaid plans and have to face some competition issues in those sectors. As well, they gained new members in medicare programs, resulting in a revenue growth. In the Medicare sector, they have seen good revenue growth, where the company continues to expand its Medicare Advantage enrollment and benefit program offerings.
Expenses and Margins: Total cost of services were $106.9 billion and $107.6 billion in 2022 and 2023 respectively, for the full year. As such, a majority of revenues from sales of insurance goes straight out as expenses. Thus, a big driver for the profitability is to lower medical costs. The adjusted SG&A ratio increased to 8.1%. For 2023, the company’s operating margin was 1.9% and 2.5% of revenues. The company’s earnings had volatility and faced a reduction. This shows that operational expenses and the costs of selling are very high for the company. As shown in their recent quarterly reports, high health care costs are eroding profits. The adjusted net earnings per share have also been volatile in recent times, having fallen considerably. In the recent earnings call, management stated that they are focusing on reducing costs, improving efficiency, and automation to help reduce the costs.
Free Cash Flow: It was $6.1 Billion in 2023, up $2 billion from last year. The company has had a steady cash flow, showing its ability to generate cash even with the increased market volatility, costs and expenses, and operational issues. The ability to generate cash will help it in funding its future projects and for possible buybacks.
Debt: The company has a decent amount of long-term debt, at around $17.86 billion at the end of 2023, which is an increase from $17.73 billion in 2022. Also, they have nearly $6 billion in current portion of long-term debt, which needs to be paid off soon. They also carry around $11 billion in short-term debt, thus, the overall leverage is very high. This debt level makes the company highly vulnerable to interest rate hikes. The company carries approximately $1 billion in interest expense each year and is likely to increase more. The debt-to-equity ratio stands at 1.02 which is considered high.
Equity: Total equity sits at around $20 billion at year end 2023. The company is very reliant on external funding and is highly leveraged. However, the company does have cash reserves on hand, currently close to $10 billion.
Acquisitions: A portion of their growth is made through acquisitions and mergers. They have a track record of acquiring smaller players in the industry and incorporating them into their current business. For this, they have to use more capital, that can increase the existing high level of debt. For instance, they have acquired Magellan Specialty Health for about $4.9 million in cash in Q4 2022. They have also acquired various companies in different sectors of the medical industry and that provides a better range of services and product options.

Moat Assessment: 2 / 5 The strength of a company’s moat depends on how well it can defend its profits from the competition. Based on my analysis, CNC has a narrow moat. Here are the details:

Limited Pricing Power: The industry is very competitive, and thus, the company has limited ability to raise prices. The company’s pricing is largely dictated by the government, they cannot arbitrarily increase prices when expenses go up. Also, the industry lacks any pricing differentiation or pricing power, and thus, companies tend to offer similar services at similar prices. As such, there is very little pricing power for the company.
Switching Costs: Some consumers have some switching costs because it is a hassle for them to change the program they are already part of. For instance, with Medicaid or Medicare, the customers are largely tied to their provider for a particular year at least, as their physicians are likely tied to the specific system. It takes significant research, planning, and time for any customer to move from one health insurance provider to another. Therefore, CNC enjoys some level of customer retention, but it is not as strong as in other sectors.
Economies of Scale: CNC does benefit from economies of scale and has a sizable market share. But, they need scale to bid for large government contracts. Also, scale might give them better negotiating power over certain contracts with pharmacies and other medical companies. This is a positive for the company. However, since prices are highly competitive, and there is intense competition, scale alone is not enough for a strong economic moat.
Intangible Assets: The brand names of managed care insurance companies are typically not an important consideration for customers. Brand image and perception are not as important in this space. However, there is some brand association through their wide network.

Risks to the Moat and Business Resilience: Here’s a list of factors that could pose a danger to Centene’s moat and general business resilience:

Regulatory Changes: Changes in federal or state regulations, reimbursement policies, and eligibility criteria can lead to uncertainty in the company’s future revenues and cash flows. For example, the Affordable Care Act (ACA) has resulted in changes in coverage and risk-based premiums. The ongoing ACA litigation also poses some threats. Since Medicare and Medicaid are such a big portion of their business, a government decision to significantly change payment policies could be devastating for profits. Political pressures can also impact the contract amounts they may receive, especially in the Medicaid sector where margins are already low.
Increased Competition: Further consolidation in the industry may make competition more intense. If bigger players choose to use their scale aggressively, the company may not be able to effectively compete with them, especially in the Medicaid sector, due to small margins. New entrants to the market are always an ongoing threat.
Operational and Execution Issues: The company has to properly execute the operations, improve customer satisfaction, implement IT and technology strategies to reduce operating costs. Failure to do that effectively will adversely impact their financial performance.
Integration Issues from Acquisitions: Integration of the acquired businesses with the parent company is a complicated process. Problems in integration may lead to a slowdown in benefits and profits and may impact the growth trajectory.
Political Influence in Winning Contracts: Sometimes political influence also plays a role in winning government contracts. If a company is not well connected, it may be tough to acquire the government contracts even if it is the lowest bidder. Thus, the company’s growth trajectory could be affected by their political influence. For example, in a recent development, the CEO is seen to be trying to have closer ties with democratic senators to prevent bad rulings.
Economic Downturn: Economic downturns can negatively impact the ability of individuals and governments to pay for healthcare. As a result, the demand and the price for healthcare premiums can go down, greatly affecting CNC’s financial results.

Understandability: 4 / 5

The business is relatively complex, owing to the nature of health insurance and the many moving parts involved with government policies and regulations. As such, the following factors make it somewhat difficult for the common individual investor to understand the business:

Complexity of the healthcare industry: The complexities of the US healthcare system and constantly changing regulations make it hard to understand.
Lack of transparency: It is hard for investors to see a clear path in the government contracts and the pricing mechanism. The government’s complex and non-transparent dealings are hard for investors to analyze and understand.
Acquisition of many businesses: The company keeps buying many smaller companies in different spaces, and this makes it very difficult for the investors to understand the overall working of the company.
Accounting: The company’s financial statements are also complex to understand due to the high use of accounting techniques, goodwill and non-recurring charges. Investors have to do additional analysis and research before understanding the underlying financial performance. Also, the cashflow statement is significantly different from the traditional companies due to the complex accounting structure.

Balance Sheet Health: 3 / 5

The balance sheet health is average. Although it has sufficient cash in hand to cover liabilities, its debt levels are considerably higher than its equity, increasing the vulnerability of the company. Here is the overview:

High leverage: The company carries more debt compared to equity. This can impact the company if interest rates continue to increase. Also, they are more prone to changes in financial conditions.
Good liquidity: The company does have sufficient cash on hand to cover immediate liabilities. As such, they can be considered to have a good liquid assets to cover near-term debt liabilities.
Good asset level: The company has good asset level with $82 Billion in assets, they will continue to provide value to the shareholders.