Anthem Remains Undervalued After Solid First Quarter

Narrow-moat Anthem ANTM reported solid first-quarter operating results and, perhaps more importantly given the backdrop of the ongoing COVID-19 crisis, maintained its earnings per share guidance for 2020. We are maintaining our fair value estimate ($348 per share) and believe that Anthem's shares remain undervalued.

In the first quarter, Anthem reported adjusted earnings per share ($6.48) that mildly beat Capital IQ consensus ($6.44) and allowed the firm to maintain its bottom-line guidance for 2020. Specifically, Anthem still expects to generate at least $22.30 per share in adjusted earnings, which remains in line with our expectations. The company also generated substantial free cash flow of $2.3 billion in the quarter, up from $1.4 billion in the prior-year period. In general, we no longer remain concerned about medical costs spiking out of control in 2020 because of the COVID-19 crisis. Rather, Americans appear to be avoiding healthcare services due to social distancing initiatives, and Anthem estimates that 30% to 40% of its annual medical expenses are related to deferrable elective procedures.

We believe the major COVID-19 risk relates to the economic downturn due to shelter-in-place orders that are contributing to massive layoffs. If those layoffs are sustained, employer-based membership rolls, which represents roughly 70% of Anthem's membership rolls, will likely decline. However, all else being equal and including the effects of recently generated cash flows on our model, we think Anthem and the other insurers have substantial room for membership to fall in 2020 before we would change our fair values, assuming a mild recovery starting in 2021. Also, we would note that increased insurance rolls for individual and Medicaid business lines (about 20% of Anthem's current membership rolls) could rise and somewhat offset the commercially insured losses for insurers like Anthem, as well, during a slow economic period.

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