Centene Corporation (CNC) Earnings Call Transcript & Summary

And welcome to our next presentation here at the Morgan Stanley's Global Healthcare Conference. I'm Ricky Goldwasser, Morgan Stanley's health care services analyst. And it's a real pleasure to have the Centene management team here with us. So here on the screen with me are Michael Neidorff, Chairman, President and CEO of Centene; Drew Asher, CFO; Vice Chairman of the Board, Sarah London; and COO, Brent Layton. We have a slide deck that's available on the Centene website that you can refer to during Michael's opening remarks. But before we get started, please just note that the webcast is for Morgan Stanley's clients, not for members of the press, and that for any important disclosures, you can go to the Morgan Stanley website. I also just wanted to quickly just sort of introduce everybody to the Morgan Stanley Alliance for Children Mental Health that uses the resources of Morgan Stanley Foundation in collaboration with the expertise of our key nonprofit member organizations in the mental health space to help address children's mental health, specifically with far-reaching challenges of stress, anxiety, depression. And now more than ever, we need urgent, coordinated efforts to prevent the existing global crisis in children's mental health from escalating, and you and all of us can play a role in this effort. So we encourage everyone to learn more about the issues that children are facing around their mental health and become advocates for change, and you can learn more about it by visiting morganstanley.com/mentalhealthalliance. And with that, thank you again. And Michael, we'll turn it over to you.

Thank you. Thank you very much. Great to be here. I'm joined today, as you just said, by the Centene leadership team. Sarah London, our Vice Chairman of the Board, [indiscernible] will talk about that in a minute; Brent Layton, who actually picked up the President title and became President and COO of the company; and Drew Asher, of course, our Executive Vice President and CFO. Earlier this month, our Board of Directors appointed Sarah London, President of the Centene Health Care Enterprises and Executive Vice President of Advanced Technology, as a Vice Chairman of the Centene Board of Directors. Additionally, Brent, Executive Vice President of U.S. Health Plans, Products International was appointed to the role of President and Chief Operating Officer. Sarah and Brent have both demonstrated the innovative leadership and strategic decision-making needed for Centene's next chapter of value creation and on executing on the plans that we're talking about today and have been talking about. This phase in our organization plenty aligns with our leadership to our strategic priorities and accelerates the impact on the business. In addition, the Board has expressed their intent -- this is important, to return the size of our Board of Directors from the current 13 to 9 to 11 individuals. We will be working with the Board on how to best do that over the next 4 to 6 to 8 weeks. Today, Sarah and Brent will highlight recent progress across our portfolio. We also want to emphasize our ongoing commitment to unlocking value across the enterprise by reaching our goal of adjusted net income margin of 3.3% or better in 2024. Drew is going to discuss several initiatives in place to drive margin expansion while still growing our top line. I think that some of the charts you will look at I'm going to show you the -- generally some of the activity. And then at our Investor Day in December, you'll get a lot more granularity as best we can explain them. I'd like to take this opportunity to remind you that the future planning has to be predicated on the fact that COVID will be here for some time. We see this as an ongoing event, not something that's episodic. But we believe we have the agility and are prudent to continue to effectively manage through this evolving environment. Part of it is our diversification. Our scale, our size we've worked to build, the number of states, the number of products we're evolving has -- gives us the ability to have offsets as we move through this. So we look forward to this conversation. I'm going to hand it over to Sarah.

Thank you. Thank you, Michael. Good morning, everyone. As Michael said, we have a tremendous opportunity ahead of us, and I'm very excited to take on the role of Vice Chairman at a pivotal time for the company. Michael, Brent, Drew and I, along with the rest of the management team, have obviously been laser-focused on executing in an unprecedented and I think, as we all know, ever-changing pandemic environment. But we have also been shaping a transformation agenda. And it is one that's designed to create value for all of our stakeholders in a way that is consistent with our role as a leader in government-sponsored health care. As we sit here today, Centene is the largest Medicaid managed care organization in the country. We are also the top #1 carrier on the health insurance marketplace, and we have demonstrated strong growth in Medicare Advantage. And when you bring all of that together, we absolutely recognize the inherent mandate to leverage that size, scale and expertise to drive margin improvement and earnings performance. We certainly still believe in growing and investing, but with a focus on our core business. And that value creation framework is and will continue to be our top priority. So with that as an introduction, let me turn it over to Brent to give some updates on the business.

I'll start off with North Carolina. The Medicaid managed care program actually began in July 1 of this year. And in North Carolina, we actually have 2 health plans: one is WellCare, and WellCare is actually statewide for the program there; and our other is our partnership with the North Carolina Medical Society, Carolina Complete Health, where we are in 3 of the 6 regions. Additionally, we were very excited to be re-awarded contracts in Nevada and, of course, in Ohio. We see strong momentum continuing in Medicare Advantage in 2021, and we're pleased with our growth. We see a long runway, and there's many reasons for it, but specifically strong benefits, and more importantly, a strong provider network, where we're focused on value-based reimbursement models and at the same time partner with our providers. And some of our models are around our proprietary Model One, which we're seeing tremendous acceptance and growth working with our providers. Now in Marketplace, our Ambetter product, we're very excited to have a very supportive administration that wants to see the exchange program grow. And clearly, this can be demonstrated no better than the enhanced advanced premium tax credits, which has clearly grown the overall pool of people getting coverage and insurance in the country today, and we are appreciative of their leadership. From there, Sarah, let me turn it back over to you.

Great. Thanks, Brent. I'll give a quick update on the Magellan transaction. The acquisition is moving along. We have all approvals except one and still anticipate that, that transaction will close by end of the year as planned. And then I'll turn it over to Drew to provide more details. But before I do that, I just want to reemphasize how committed this management team is to our value creation plan. The entire enterprise is focused on unlocking value. And we were actually talking about this earlier this morning in one of the conversations. But one of the thing that -- things that's been great about organizing against this effort since the Investor Day is seeing the enthusiasm throughout the organization for taking a new approach and thinking about efficiencies. And everyone is focused on achieving our target of at least a 3.3% margin in 2024. I also want to emphasize that we have multiple avenues to get there, and so we're taking a diversified approach to the program, everything from financial discipline to maturing our operating model and expanding both clinical and technology initiatives. And of course, we will be disciplined in capital allocation with a focus in the near term on achieving investment grade and share buybacks in 2022. But again, I'll let Drew provide more details.

Thanks, Sarah. That's a good way to put it. We're all rowing together as a company focused on the value creation plan, and it is our #1 priority and probably will be for some time to come. But before we go into the value creation plan, we thought it would be helpful to give you some recent updates. We posted the slides earlier. So if you're following along, look at Slide 5. And we're going to give you some month-to-month insights, and it's not meant to be precedent setting for every intra-quarter investor event. But given that we're living in unusual times with COVID-19 impacts, we thought it would be instructive to give you an update, although we're sitting here intra-quarter. So in July, we saw subsidence or slowing of pent-up demand for the non-COVID cost, which was a really good sign because you'll recall, coming out of June, we had seen sort of movement back upwards. So that was good to see in July. But then towards the end of July, consistent with the national data, we witnessed rising inpatient authorizations due to the Delta variant. The COVID authorizations and related costs, they continued into August and spiked after the third week of August. At least for now, that's begun to settle and come down as we exited August. But importantly -- we're sharing this insight with you. But importantly, the takeaway is that non-COVID has served as an offset, and we remain on track through August, so through 8 months of 2021. And accordingly, we're reaffirming our adjusted EPS guidance of $5.05 to $5.35. Of course, as we look ahead, we'll continue to track COVID cost utilization, non-COVID utilization and the presence or subsidence of pent-up demand across all of our businesses. So let's pivot to 2022. I'm not sure all of the sell-side who formed 2022 consensus have completely digested the multiple times we've said publicly the fruits of our labor will show up more so in 2023 and 2024 than in 2022. But having said that, we do intend on growing adjusted EPS modestly in 2022, with acceleration into 2023 and 2024. And we're still working on the 2022 budget. And per our custom, we plan on providing detailed guidance at our December Investor Day. So if you look at Slide 6 and 7, pivoting to the value creation plan, we're very excited about this, as Sarah and Brent indicated. It's being directly driven by Sarah, Brent and myself and, of course, in conjunction with functional and business leaders of Centene who are energized to achieve the size and scale and get the benefits of that size and scale in our businesses. So we've canvassed the company to identify the universe of opportunities. We formed, importantly, the proper governance, and we began taking action on pulling levers that should bear fruit in the future. We've listed some of those examples and related actions over the next few years on both the chart as well as the bar graph. And so it's pretty obvious that some of these initiatives will begin to show benefits in 2022 and ramp thereafter such as SG&A initiatives, clinical initiatives that are not really onetime events. They're perpetual, and we're accelerating those. But then there's other initiatives that will require more time for execution such as operating model changes to reflect our size and scale, for instance, the RFP we intend on issuing for our PBM services because our current contract ends 12/31/23. And those are just a couple of examples that you'll see on those slides. And we're going to value the buckets of the opportunities at our Investor Day in December and begin reporting quarterly on specific progress in 2022. Simultaneously, we expect to deploy capital, consistent with what we laid out at our June Investor Day. And so after satisfying current obligations, we anticipate about 1/3 of that free cash flow will be used to support organic growth, whether it's risk-based capital or investments necessary to grow, and the remaining 2/3 is available for debt management, bolt-on M&A and share buyback. Let me hover for a minute on debt management to explain why. We believe we're in the 2-yard line for investment grade. And in the intermediate term, we expect interest rates will rise. And then it's important for investors in the company to keep interest costs down in the long run as an investment-grade issuer. We also believe though that share repurchase is an attractive part of a balanced capital deployment strategy, and we expect to do so in 2022. In addition, as part of the value creation plan, we are considering divestitures of noncore assets, and proceeds could provide an earlier opportunity for share repurchase. So thank you, Ricky, for letting us tag team a quick but very important update. And Ricky, we can proceed to the panel Q&A.

Great. Thank you very much for the update, and a lot here. I got some questions from the audience. I'll get that out of the way quickly, as it relates to the numbers. One question, Drew, is for you regarding the 2022 implied guidance, modest growth. I'm assuming that the jump -- the starting point is your 2021 guide to 2022. But the question here is if you can just walk us through the headwinds in 2022 that are weighing on the EPS growth versus '23 and '24.

Well, '23 and '24, we expect the acceleration from the actual initiatives that we'll be implementing. We've already started some of them, but most of them ramp over the next couple of years. So that really will be the tailwind in addition to sort of the normal operating churn of the business. We'll get into more headwinds and tailwinds next year but -- at the Investor Day in December. But things that are factored into our view, that we're going to modestly grow adjusted EPS for 2022, includes the Magellan acquisition, redeterminations through the summertime of next year. Our most recent call on that was through '21. But obviously, with the PHE and the extensions and all the factors that play into the PHE, public health emergency, decision-making, we think that will extend, but then commence after summer of 2022. So then that becomes a slight headwind as we get into the back part of 2022. And the Medicaid performance has been really good. And so a more normalization of the HBR for Medicaid are some examples.

Great. And then another follow-up on the numbers. If you think about third quarter EPS, you're saying you're on track. I think consensus number is $1.24. Should we anchor the on track versus that? And another follow-up question that we got here was just kind of like how should we think about the balance between operating expenses versus MLR, i.e., is MLR is still on track for the year?

Well, we're 2/3 through the quarter. So it's great to be able to provide that update. And our update is on overall aggregate adjusted EPS. But obviously, the HBR is the biggest leverage item to the bottom line for adjusted earnings per share. So we're sort of on track as a whole through August. Tough to predict the future, but with 8 months under our belt, we feel pretty good about our ability to achieve somewhere in the range of $5.05 to $5.35. So that's where we stand as of the end of August.

And we did take through that 50 basis point adjustment to the MLR.

Yes. Right. Coming out of the second quarter, it was 40 basis point increase in the midpoint of HBR. That clearly helped with some of the pent-up demand, and we saw that slowing, which was good, as I mentioned in the presentation in July. And -- but we did have to cover, and this is important to understand because this sort of goes to the size and scale and diversification of the company. The inpatient authorization spike for Delta was higher in August. It peaked in late August, and we see it coming down, at least for now. That was actually higher than the December -- late December, early January last peak of COVID. It was a lot quicker, and it was most severe in Marketplace in terms of the cost impact. But non-COVID was an adequate offset for us to be able to be comfortable and pleased to reiterate guidance.

And I'll just add -- I want to add one thing. I think it's important that outside of the southern states where we see high acuity, there's a lot of states that we're seeing where normal utilization is still occurring and hospitals are not shutting down the elective procedures. So it's a little different environment. People [indiscernible] because they have to.

Michael, one question for you that we get a lot from investors around Medicare rates and risk adjustments, there's just growing consensus that adjustments to risk scoring is going to happen at some time. One, do you agree? And second of all, what do you think the magnitude could be? And would that impact sort of kind of like how you think about 2023?

Yes. [indiscernible] guidance in '23 [indiscernible] the risk adjustments we do see dissipating, I mean, Brent will have to comment on both.

There's always discussions on it, and there's always changes that the federal government is looking at. But looking at the complexity of our membership from that standpoint, we would expect these potential changes to actually improve accuracy and ultimately, not to really impact in a negative way our rates.

Yes. Ricky, as you know, it depends on sort of the aggregate rate structure. There's always elements in there that sort of push at you, and then there's sort of rate elements that are accommodating for the continued success of Medicare Advantage. So it really just depends on the aggregate rate picture for '23 and beyond.

Okay. Great. Sarah, I want to ask you this question. You were recently appointed to the Board as Vice Chairman. What are your top priorities in -- as Vice Chairman of the Board?

I think you just heard most of them. I see my role very focused on operations. And like I said, I think we have -- it is a pivotal time in the company's trajectory. And I think the need to -- obviously, everything Drew covered from a financial discipline perspective is -- remains a priority. But really, organizing the company to take advantage of our size and scale is a huge priority. And there are a number of different ways that we're going to do that. Obviously, near and dear to my heart is technology and its ability to help drive that. But thinking differently about what we standardize and how we maintain a local approach while also acknowledging the benefits you get from centralization and not just operating benefits, but the knowledge and expertise benefit you get by bringing some functions together, that is really our focus. And again, I don't think about a Board role and a Board focus is any different from day-to-day because I think getting the day-to-day right is the #1 priority.

And Brent, sort of similar to you, if you think about all these complexities of the Marketplace that we're seeing now, what are you spending most of your time on?

Well, #1 is Marketplace. So looking at our Ambetter product, it's clearly a change in environment from that standpoint. And clearly, then you throw COVID in, which is -- you've heard Drew speak about, always has a dramatic impact. But most of all, spending time with providers and focusing on providers, provider partnerships, focusing on our highest quality providers, working very closely on value-based reimbursement models, specifically such as our Model One approach, which is proprietary to Centene. And ultimately, we really believe those partnerships and focus on the providers and proper reimbursement programs for both parties pulled together as one is really what value creation is about. And when we talk about increasing our margins, this is where the rubber hits the road, and this is where I spend a lot of my time. And really, we're going to spend a great deal more time.

Great. We got lots of questions here. But one that do want to kind of like -- just kind of like throw out there, when we think about the key segments, Medicare, Medicaid exchanges, should we think about sort of the in-line results? Are you seeing sort of in-line results across the board in all the different markets? Or is Medicare or Medicaid or Medicare Advantage ahead of plan in offsetting continued potential pressures or pricing in the exchange side?

Yes. I think you've hit on, and we talked about this earlier, where Medicaid is performing well despite -- even the COVID impact in August on the Medicaid population for the Delta variant. Marketplace, as we covered at length at Investor Day and our Q2 call, is seeing pressure this year. And so we expect to improve Marketplace next year. We took those actions in pricing to reflect an improved margin for next year. And then one of the headwinds, as you mentioned or asked about, is the -- we're being more holistic with the Medicaid HBR as we think about next year in terms of balancing out the portfolio. Medicare Advantage is performing fine. I think it can do better. I can't wait to impact the bids for 2023 and 2024. And so that will be another earnings growth lever as we look out towards our 3.3%-plus adjusted after-tax margin goal for 2024.

And Drew, this is actually a question that we got around sort of kind of like -- you alluded to the 2023 pricing for MA. So I guess the question is like how are kind of like recent trends that you're seeing influencing sort of how you think about the 2023 pricing. Are you anticipating more competition? Or you just kind of like thinking of it -- there's an opportunity there to gain market share?

I think -- I will address this, and then the others can jump in. I think we've demonstrated we're never going to join any races to the bottom. I think that proved to be the right approach. And so in the case of Marketplace in that -- with the -- and the tax credits being extended, maybe made permanent, so that pricing advantage and our approach to be able to prove to be a clearly solid one. And then I'll let the others [indiscernible].

Yes. The good news, we're going to be working closely over the next about 9 months or so before we have to submit the 2023 pricing, working closely with Sarah and Brent in terms of the trade-offs and levers. And obviously, we still want to grow. These are growth businesses. But margin is pretty darn important, and it's going to take precedent as we balance out margin and growth in the Medicare bids as well as the Marketplace bids. But there's still time to play out to see what happens over the next 8 or 9 months before we make final decisions on bids. But at least you'll know the theme, margin expansion, but we still are in a growth business. And expect to be able to do both, maybe not at the Medicare levels we've seen recently, but it's still a growth business, and the pie is also growing in Marketplace.

Great. So we have a couple of minutes left to our fireside chat here. And Michael, as we look back over the last 2 decades, you've significantly transformed Centene from a pure Medicaid play to a diversified, tech-enabled health care company. As we look out, right, as we look out to the next decade, what areas of white space opportunities in the health care marketplace do you view as currently underappreciated but with really strong potential growth opportunity for the company?

I think it's -- the businesses we're in now have growth opportunities. We start off with the core businesses. And I think we have the team in place that has the marketing, the cost management, the medical management strategies. I see that continue to grow profitably. We have several new products we're working on, which for competitive reasons I'm not going to go into a great deal of detail, but we think will allow us to continue that profitable growth and our margin expansions. And so over the next decade, I see us continuing to be a leader in an ever-expanding market. And I -- some of these new products are very exciting. The technology things we're doing, allowing us to generate a lot of cost savings and allow for that reinvestment. So it's going to be a case of very balanced growth. The last 2 decades have really been the case of getting critical mass. This is a critical mass business. The number of states we're in, though we have some deep, red states in the south that have high COVID, impossibly in hospitals, that's not the case up north and in other markets. And we're coast-to-coast, north border, south border, we're well represented. That was part of the strategy. We're now going to capitalize that and add new products to that benchmark. Anyone would add in?

That's well said. Michael has been very clear about diversification for the 2 decades I've had the opportunity to work with him. And that has led us as we developed our products and our approach and we'll continue it.

Margin expansion is this organization's [ mind. ] And there's a lot of employees that have stock in this company. So we're on board with the investment community. We want to see this company grow profitably and leverage the size and scale that we are now. That's what it's all about.

Great. Well, Michael, Drew, Sarah, Brent, thank you very much for your time, and thank you for all the updates.

[indiscernible] Stay safe.