Investment Thesis

Humana (NYSE:HUM) attracts a high earnings multiple, likely a carryover from past strong EPS growth. If earnings come under pressure from the effects of a recession, share price will likely come under pressure from a combination of lower EPS and lower P/E multiple. Humana is a solid company with growth potential, and a lower entry share price would help to mitigate against those risks.

The Dividend Growth Income+ Club Approach

The logo of the DGI+ Club explained:

Total Return, Dividends, Share Price

The only way an investor can achieve a positive return on an investment in shares is through receipt of dividends and/or an increase in the share price above the buy price – the only way.

Assets, Liabilities

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The engines and the lubrication, along with human talent, driving the business. Shareholders have no legal rights to or ownership of the assets. Shareholders in a limited liability company have no legal obligations with respect to the liabilities.

“Equity Bucket

Shareholders have an equitable entitlement to their equity in the company. Equity is increased by capital raised from shareholders and by earnings of the company. While shareholders have an equitable entitlement to their equity in the company, they have little to no say in how the equity is distributed. In some companies, management actions with respect to shareholders’ equity does not always benefit shareholders and can be highly detrimental to shareholders. At the DGI+ Club, in addition to reviewing profitability, balance sheet strength, liquidity and other metrics, we take the extra step of checking the “Equity Bucket” for “leaks”, i.e., effective distributions out of equity that do not benefit shareholders.

Below I address for Humana:

  1. Historical And Potential Future Shareholder Returns
  2. Checking the Humana’s “Equity Bucket”

Humana: Assessing Historical And Potential Future Shareholder Returns

In this article and in most of my articles, I seek to show how targeting a desired return on an investment in shares can be facilitated by actually estimating what future returns will be based primarily on analysts’ EPS estimates and other publicly available data. After all, gaining a return is the primary aim of most investing.

First, I provide details of actual rates of return for Humana shareholders investing in the company over the last five years.

Table 1 – Humana: Historical Shareholder Returns

For many stocks where I create a table similar to Table 1 above, I find a wide range of returns indicating a degree of volatility and risk. Table 1 above shows the results for Humana were strongly positive for seven of eight different investors, each investing $3,000 over the last five years and holding to the present. The lower return for Investor H in Table 1 is due to that investor buying at a far higher share price than the other seven. These rates of return, ranging from 7.5% to 43.8%, are not just hypothetical results. They are very real results for anyone who purchased shares on the various dates and held through to June 12, 2020. In the above examples, the assumed share sale price is the same for all investors, illustrating the impact on returns of the price at which an investor buys shares. Duration of investment is also a factor to consider. Investor G has a rate of return of 43.8% compared to Investor A’s rate of return of 20.1%, but Investor A’s $3,000 investment has grown to $8,106 compared to $4,309 for Investor G. This is due to the duration the respective investments have been held. If Humana’s share price grows at less than 43.8% per year in the future, Investor G’s rate of return will reduce over time.

Projecting Future Shareholder Returns

If rate of return is the basis on which we judge the performance of our investments, then surely we should be seeking to estimate future likely rates of return when we are making investments. But how do we do that? I use proprietary models to generate net income, balance sheet/funds flows, and projected rates of return going out three to five years. Much of this is automated, but still involves a great deal of research and business and data analysis to back up the projections. Let us first look at the traditional approach to assessing value of a stock for investment purposes.

Assessment Based On Quant Ratings For Share Investment Decisions

Share buy price, dividends, share sale price, and duration the shares are held are the only factors affecting the return on an investment in shares. That makes the potential share sale price the single most important and uncontrollable unknown when making a share buy decision. My expertise is in fundamental analysis, but I do recognize any methodology, Quant or Elliott Waves or other techniques providing assistance in assessing possible future share price direction, can be of benefit to share investors. I find SA Quant ratings useful for both screening for stocks of interest and as a form of due diligence.

Figure 1

Quant ratings for Humana show the company is strong on a majority of factors.

  • For “Value,” the main factor Humana scores poorly on is Dividend Yield (TTM) with a “D+” rating. Price/Book and P/E Non-GAAP (TTM) are also lower with “Cs”.
  • If I click on “Growth,” I’m taken to a list of 17 fundamental measures each individually graded. For 15 of these 17 measures, Humana earns five “As” and ten “Bs” for growth compared to sector medians. Cs are earned for Revenue Growth (FWD) and EBIT Growth (YoY), based on comparison to sector medians.
  • The “A” for “Profitability” reflects above sector performance for Return on Capital, Gross Profit and EBITDA and EBIT Margins, and Cash Flow metrics. The only areas of weakness are “Ds” assigned for Gross Profit Margin (TTM) and CAPEX/Sales (TTM).
  • For “Momentum,” Humana earns As and Bs for share price momentum for 6 months to 1 year, and a “C+” for three-month price performance, once again compared to sector performance.
  • For “Revisions,” Humana earns a “B” due to nine upward EPS revisions and eight downward revisions over the last 90 days. The sector median has two downgrades for every one upgrade over the last 90 days, reflecting the impact of COVID-19.

Assessment Based On Analysts’ EPS Estimates

Figure 2 – Summary Of Analysts’ Adjusted Non-GAAP EPS Estimates

Some observations on contents of Fig. 2

  • The analysts’ quarterly EPS estimates for consensus, high and low, do not add to the yearly EPS estimates for consensus, high and low. This is generally the case because the analyst with the high estimate for the year is not necessarily the analyst with the highest estimate each and every quarter, ditto low and consensus figures. To overcome this, I adjust the quarterly EPS figures in the proportion of yearly totals to quarterly totals.
  • The further out estimates are made the less certain they become. The 2023 and 2024 estimates, due to being covered by only two and one analyst, will be even more uncertain. Although I will include these in my projections for completeness, I do not intend to comment on or draw conclusions in respect of these out years.

I incorporate the above analysts’ EPS estimates from SA Premium into my rate of return projections utilizing my proprietary 1View∞Scenarios Dashboards further below. As for Quant ratings, EPS and EPS growth estimates do not quantify the rate of return that can be expected for the stock in question.

Figure 3 – Non-GAAP P/E Ratios, Historical And Future Estimates

Figure 3 is primarily designed to determine an appropriate range of non-GAAP P/E ratios for determining estimated future share price levels for Humana. This is necessary for quantifying estimated future rates of return. Figure 3 also informs us of past non-GAAP EPS growth rates compared to forward estimates of EPS growth based on analysts’ consensus estimates. The forward EPS consensus estimates indicate expectations of growth rate of 4.4% for 2020 over 2019. Analysts’ consensus estimate of EPS for 2021 is estimated to be 18.0% up on 2020 and 23.3% up on 2019. It should be understood in quantifying the estimated rates of return below, I’m relying on the soundness of analysts’ consensus estimates of EPS. The other important factor is determining appropriate future P/E ratios, which is fraught with difficulty. P/E ratios are impacted by issues both at the macro and micro level. I don’t believe I will have any arguments against the notion current P/E ratios are influenced by expectations of future EPS growth rates. Below, I quantify potential rates of return under various scenarios utilizing my proprietary 1View∞Scenarios Dashboards.

Assessment Based On Quantification Of Potential Rates Of Return

My forward-looking analyses bring another dimension – the quantification of potential returns utilizing various pieces of financial information already available.

Table 2.1 – 1View∞Scenarios Dashboard

Table 2.1 shows buying at the current share price would provide indicative rates of return through end of 2022 of ~12% for the consensus case, ~15% for the high case, and ~11% for the low case. These rates of return assume EPS results in accordance with analysts’ consensus, high and low estimates and a constant adjusted non-GAAP P/E ratio of 20.19 (current P/E ratio Q1-2020 TTM). The P/E ratio of 20.19 is around the historical median of 20.79 and average of 20.34 per Fig. 3 above. It should be noted these historical multiples were set in periods including some very high EPS growth rates. Analysts’ consensus estimates show low growth in EPS for 2020 over 2019, but a return to EPS growth in the high teens in 2021. There has to be a great deal of uncertainty about growth for any business in 2021, as per this excerpt from CNBC:

  • The Federal Reserve’s economic forecasts reflect a wide range of views about the course ahead.
  • For 2021, Fed officials see anything from a continued recession to the biggest boom since 1984.
  • Markets have been wrestling with the uncertain path of the both the economy and the coronavirus.

Humana’s P/E ratio is also well above its peers as per this peer comparison from SA Premium.

Figure 4

Table 2.2 – 1View∞Scenarios Dashboard

Table 2.2 uses the same assumptions as in Table 2.1 above, except for a reduction in the P/E ratio from the present 20.19 to 16.0. This is still well above the forward P/E multiples for peers Anthem (NYSE:ANTM) and Centene (NYSE:CNC). Ending share price for 2020 is assumed to be 10% below the current share price (at $340.85, still well above the low of $208.25 on March 23, 2020). At the assumed lower level P/E ratio, indicative returns through end of 2022 are in low- to mid-single digits for all of the consensus, high and low cases. This should be very concerning for any holder of the shares as there is a very real risk of multiple contraction, particularly if analysts’ estimates are revised downward as the reality of an extended recession begins to be factored in.

Checking the Humana “Equity Bucket”

Table 3.1 Humana Balance Sheet – Summary Format

Table 3.1 shows an increase in shareholders’ equity of $1.7 billion over the 3.25 years, January 1, 2017, through end of March 31, 2020. There was also an increase in net debt of $1.6 billion, increasing funds available for application to $3.3 billion. This $3.3 billion was applied to increasing net assets used in operations by $3.3 billion.

Table 3.2 Humana Balance Sheet – Equity Section

I often find with companies, while they produce earnings that increase shareholders’ equity, significant amounts of distributions out of equity do not benefit shareholders. Hence the term “leaky equity bucket”. I do not see this happening with Humana.

Explanatory comments on Table 3.2 for the period January 1, 2017, to March 31, 2020

  • Reported net income (non-GAAP) over the 3.25 year period totals to $6.8 billion, ~$0.5 billion less than GAAP net income.
  • Share repurchases are not significantly offset by issues to staff and significantly reduce share count.
  • Other comprehensive income is not significant and is positive over the 3.25-year period.
  • It is disappointing out of reported non-GAAP net income of $6.8 billion, only $888 million was distributed to shareholders by way of dividend.
  • The balance sheet is strong with a net debt to net debt + equity percentage of 14.4%.

Humana: Summary and Conclusions

Humana has provided solid total returns to investors over the last four to five years. Continued strong share price growth is reliant on strong EPS growth and continued high P/E multiple. I believe both are at risk, and from that perspective, this is in fact quite a concerning stock to hold under current circumstances. A lower entry share price would compensate to a great extent for these risks.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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: Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. I do not recommend that anyone act upon any investment information without first consulting an investment advisor and/or a tax advisor as to the suitability of such investments for their specific situation. Neither information nor any opinion expressed in this article constitutes a solicitation, an offer, or a recommendation to buy, sell, or dispose of any investment, or to provide any investment advice or service. An opinion in this article can change at any time without notice.