Centene Corporation (CNC) Earnings Call Transcript & Summary

Good afternoon, everyone. I'm A.J. Rice again, the health care service analyst at Credit Suisse. We're really pleased to have next up in this room Centene, a leading managed care company, focused in the government markets. We have Sarah London, Chief Executive Officer; Drew Asher, Chief Financial Officer.

Maybe just a good way to start us off with a broad general question is we're 10 months into the year. What would you say is some of the wins for Centene? And what would you highlight as some of the challenges?

Yes. Absolutely. First of all, thanks for having us. As we look back over 2022 and, really, the 8 months or so since this management team has been at the helm, I think we feel really good about the progress to date. We are 5.5% ahead on EPS versus our original guidance in December of '21. We've hit all of the value creation and operating milestones that we put forward in order for investors to have visibility into the work that we're doing for behind the scenes. And that's not just a bunch of checkboxes on slides. That's a lot of really heavy lifting in terms of fundamentally changing how we work as an organization. And the fact that we've been able to do that and not disrupt the underlying operations, I think, is a testament to the commitment and the focus of the organization. Obviously, also just finished a very, very rigorous PBM/RFP process. Feel really good about the outperformance there in terms of the value that we think that, that decision to move to Express Scripts is going to drive for members and our state and federal partners as well as our shareholders. And I think we've also demonstrated along the way that we're able to expand margin while growing. And the margin progression in Marketplace, I think, is good evidence of that. And we applied that same discipline to the Medicare bids looking forward into 2023. A lot of good progress on the portfolio review. So divested PANTHER in progress, divesting Magellan Rx as well as our Spanish and Central European assets. We expect those to all close by the end of the year, and there's more work to do on that, which I'm sure we'll talk a little bit about. And so that, along with a lot of great RFP wins over the course of the year, I think, is all incredibly positive. From a capital deployment standpoint, I think we've made good on the promises in terms of putting $1.7 billion to work in share repurchases. We've reached investment grade with 2 of the 3 rating agencies. And we've stopped deploying capital to things that don't align with the strategy and the mission of the organization. So all in all, feeling really good. 2022 has not been without some challenges, and we tried to be very transparent about those on the recent Q3 earnings call. So while we won 9 counties in California, we were disappointed with the results in Sacramento and L.A., but it doesn't change how we feel about our work in the state, how we feel about the RFP that we put in. And we feel very, very strongly about the basis of the protest there. And so we'll continue to exhaust all avenues in that process. And then on the STARS front, we obviously had visibility to the disaster relief provisions on setting and had increasing visibility as we came into '22 in terms of the impact of the operational issues that we had in 2020 and 2021, and we're able to put a lot of focus on that in 2022, but the final results were a little bit worse than we expected. And so that's really why, on the Q3 earnings call, I think we tried to deliver 3 pretty important messages. The first is that the STARS increment plus the California downside scenarios are a $0.25 to $0.50 headwind for 2024. The second is that this management team is still committed to at least $7.50 in 2024. And the third is that we've put a lot of really important points on the Board in 2022, and that creates momentum as we go into 2023 and 2024.

That's great. In other words, it was a pretty quiet year for you.

Yes, boring. Not a lot going on.

So I just -- not to drill down too much right away at a granular level, but just on that comment about the '24 outlook, the $7.50 type of number. I guess I did encounter a little confusion on how to think about that $0.25 to $0.50 EPS headwind. Are you saying -- because it's $0.25 to $0.50, are you saying automatically, you got to take $0.25 off that $7.50? Or how does that work with the $7.50? Is there still a chance to get to the $7.50? Can you just maybe flesh that out a little more?

Yes. The biggest toggle factor in the $0.25 to $0.50 potential headwind is the California protest. So that's something to watch if we're successful there, which we really believe in sort of what we submitted and that we're best able to serve those in L.A., Sacramento and current counties, that's the biggest swing factor that could either cause that $0.25 to $0.50 headwind to persist or eliminate it.

So if you're successful in the protest and either the whole thing gets delayed or rebid, you would be -- $7.50 will be back on the table. And then if it moves forward, the range of outcomes around the protest is somewhere at $0.25 to $0.50. Is that the right way to think about that?

Yes. I mean we took everything because we're 16 months now removed from putting a stake in the ground in the middle of 2021, about 2024, right, 3 years ahead of time. And so we did look at all the other factors, some of which are tailwinds, including some of the VCO activities and interest rates and the PBM opportunity that I'm sure we'll get to in your questioning, but then we also took a look at, all right, STARS, worse than we originally thought back in '21. We knew -- as Sarah said, we knew a fair amount of that pressure. And I think there's 4 or 5 transcripts you could pull to -- like we told you there's going to be a headwind, and please listen. But it was a little bit worse than we thought back in mid-'21. So that's the biggest swing factor. Yes, there's other pushes and pulls. But as Sarah said, we're hell bent on driving results and pulling levers to get to the $7.50. We just wanted to be transparent because we've been getting a lot of questions on, hey, give us a downside. What would happen if you're not successful with the protest? Help me understand the STARS impact. So we'd sort of packaged it up to sort of paint that zone of outcomes.

Yes. Protesting a Medicaid RFP reward is not a new thing. We've got a lot of precedent out there. Now it is true that California has been an RFP in over 10 years. So maybe there's some good news to that. How do you sort of see this? What are the different decision points, trees, that can play out here? You wait for a response from the people that actually made the decision to begin with, and then there's different avenues that it could unfold. And you aren't the only one that protest. There's a number of protests as well. Any -- I know you're not going to call how it goes, but just walk us through when you expect to get meaningful information and how it could play out potentially.

Yes. So you're right that the next step is a response from, again, what we sort of see as kind of a procedural response from the department, having reviewed all the protests that came in. And you're right, it was -- there was a multiplicity of protest because there were multiple parties who protest across multiple counties, which, again, I think, points to systemic concerns in the process that we're not alone in feeling. So that's the first step. And then from there, it's really taking it to the courts. And so a full range of outcomes there, both in terms of how protracted the process can be and whether that's sort of where people file in the courts, what counties, whether they -- judges put in place temporary restraining orders. So really, you have to first get that initial indication from the department and then take it into the courts and figure out how all those processes are going to play out.

Any idea when you might hear something from the department?

No. I mean we sort of are expecting it imminently but have not heard anything yet.

And when it comes -- if need be, going to the court, do you -- does each individual protester make that filing? Or do you get together as a group and make the filing? How does that typically work?

My understanding is that we would each file individually because we all have different basis of the protest.

Okay. And then what we've seen in other protest is not unusual for the implementation to get delayed. Backing up from the stated start date, I guess, January of '24, would -- when do they have to say go ahead or -- I mean -- and again, maybe not talking about California, but just based on other protests, at what point do you get to the point where this thing is still so debated, they can't start on January 1?

I think -- yes, non-specific to California, I think at least our view would be that once you start to get within 6 months of go-live if you don't have clarity, that becomes uncomfortable as somebody who's responsible -- particularly if you're responsible for a net new implementation. But again, tolerance levels differ.

Right, right. So we've had a lot of activity. And in the second half, I mean, coming into the year, all the discussion was around reverifications, and that was the big uncertainty. I got to answer a lot of granular, but why don't you set the stage on where you think we are with reverifications? How quickly that will start to impact results, assuming we get a January 15 lifting of the PAG or whenever that would be? And yes, give us a little bit about what your underlying assumptions are about that so we can level set everyone.

Yes. Sure. So if you frame the macro and you go back to the inception of the pandemic, we've grown -- excluding wins, we've grown about $12.5 billion of Medicaid revenue. And so as we map out the cohorts that are most likely to be redetermined and take a look at what business may stick versus be redetermined, our best estimate now is about $7.5 billion to $8 billion of that. So about 62% at the midpoint we would -- we're assuming we'll be redetermined and, therefore, split over '23 and '24 in terms of a revenue headwind. So those will be -- that volume will be a headwind. At some point, based on the current set of rules, it would be mid-January for a [ 2 to 1 ] effective and then ramp up throughout '23 and spill into '24. So we'll have to wait and see if that date sticks, but we would expect that over the next couple of years.

And I think there's a bunch of different assumptions about how quickly states will act. If we get it lifted in January, they start in February. But we've heard some people say it's going to take 8 months for the average state to even get really moving. There's also some CMS directives to not do so much in every month. I mean how much of that -- you're giving a revenue number. I'm thinking lives -- of the ultimate lives that get taken off, how much are likely to be done by the end of '23? And how much would still need to be reverified in '24? Is there any visibility on that at all?

Yes. I mean it's all estimates. And you're right, it's easier to frame the ultimate run rate impact than pick the precision of timing of every state. But we're doing that in our modeling, and it's based upon collaboration and conversations with all 30 of our customers. And so there's some event that might publicly say, we're going to go fast. But when we talk to them behind the scenes, they're like, we're not prepared for this. We don't have the staffing. We're going to take at least 10 months. So we factor in what they tell us and what we know they're prepared for as we model out, call it, $4 billion to $4.5 billion of that hitting in 2023, but that's the sum of 30 slope lines, and we'll just have to see how quickly -- some states are going to go pretty quick. I think most will take their time. And the vast majority of our footprint, we believe, will take 10-plus months.

I think you said something like 80% or something. We did the math, and some of it also depends on the states, whether they're doing anniversaries, right, which would then actually take that 10-month time frame and make it even longer. The one trend we have seen is that as the PAG has gotten kicked, the time lines have grown, I think because of an acknowledgment that there is just real administrative complexity. General consensus, bipartisan consensus that covered continuity is really important and the realities of staffing issues at the state level. And so the preparedness and the need for that, I think, has hit people in a different way as they started to think about it.

And just to make sure, because people throw around the 8 months to 10 months, are you saying they'd be done at 10 months or they would just be really ramping up at 10 months?

Some may wait 10 months to start the process.

Okay. Okay. Yes. I think you guys have been pretty conservative. Maybe I'll throw that out. You may not take that word. And your assumption about your public exchange recapture of these labs. I mean you've got -- you're the biggest player on the public exchange marketplaces. You've got a lot of overlap with your existing Medicaid book. You've got a lot of -- there'll be a lot of lives up for grabs from other people's Medicaid books. Can you just comment a little bit when you think about that $7.50 and all the numbers for '24, what you've assumed in terms of recapture? And do you think that's one of the swing factors that could ultimately be a positive for you?

Interestingly, I just had the same conversation with our Marketplace actuarial and finance teams.

You say they're low volume, budgeting. Is that what it is?

I always -- it's my job to push as well to see where the opportunities are. We're relying on a number of studies in terms of what will peel off to the employer group business, which most studies say a fair amount of that will make its way into the workforce. Then there's an uninsured component. And -- but our footprint matches up nicely, 25 states out of our 30 Medicaid states, we've got a Marketplace product. And we can also pick up other people's redetermined business. So we're going to stick to a couple few hundred thousand ultimate for now. We'll just have to see the pace at which redetermination is uptake, and that will give us some more data into '23 on whether there's an opportunity beyond that.

And just to think about that exchange business, I know you had pulled back a little bit this year in terms of pushing for enrollment growth to the extent of trying to get margins to where you want them to be. Any early comments about what you're seeing for '23 and what do you think -- how you think that will play out?

I think overall, we feel very good about our positioning going into open enrollment. And I think the disruption that we saw just before the process started in the Marketplace provides an interesting organic -- potential organic growth opportunity for us. And particularly in some of those major markets, I think it's demonstrated the power of the relationships that we have with the states, with the DOIs and our ability to actually step in and help support to create continuity for members. So I think there are some positive tailwinds relative to ultimately competition, pricing stability, sort of rational behavior in the marketplace, and again, some opportunity to pick up some of those lives from folks who are exiting.

Interesting. Okay. Moving over to another area that has an open enrollment period right now underway is Medicare Advantage. I think your stated goal, given some of the comments, was mid-single-digit enrollment growth with expanding margins. Given what you've seen so far, are you on track for that? Any reason to think there might be an upside to the enrollment? What are you seeing?

I think it's still early there, but we are still tracking to low to mid-single-digit growth.

Okay. Okay. And then I guess it's hard to know at this early stage, whether any of that indicates margin improvement or not. I mean it's more about your pricing, I guess, than the type of members you'll get. Is that the way to think about it? So to the extent your pricing holds up, you should see the margin expansion.

Yes. For '23, membership becomes more of the variable because of the way we set the bids to achieve margin expansion. And we have to see how the competitive nature of our benefits play out in the market versus the competition. But we're pretty resolute in taking a step towards margin, especially when we know we've got to take a step back in '24 because of the STARS headwind. So there is no good reason to over enhance benefits for '23 just to have to take those away from seniors in '24. So get the margin when you can in '23, take a step back with the STARS headwind. And then '25 and beyond as we step back into STARS programs where we can produce results, then we can sort of better balance growth and margin over the next few years.

And when you think about the STARS hit in '24, are you -- you haven't talked as much about mitigation in terms of moving people across plans or anything like that. Is there any meaningful opportunity for that, that you're contemplating? Or is it more weathering through it, like you said, and then hoping in '25, you're back on track?

Yes. Well, at low single-digit percentage and 4 STARS, there's not a lot of other opportunities to move members around, especially geographically our 4 STARS down in Houston. So we're thinking about that in terms of the sales process for the '23 AEP, but it's something we just have to weather through. It's a headwind we knew that we would have. It was effectively sealed in late '20, early '21. And now it's all about '25, '26 and '27, stepping into that 60% goal by '27 revenue.

And can you -- is there good visibility on getting that uplift in '25, '26? Or is there a fair amount of uncertainty? I mean historically, when we've seen people have STAR issues, it's taken a couple of years to get back on track. But you seem optimistic that you'll see meaningful improvement in '25 and '26.

Well, part of it is that we had the visibility coming into late '21 and into '22. So we've had almost a year of very focused operational work to build the platform so that we can get to that at least 60% and 4 STARS over the next 3 cycles. And it also -- a big piece of that -- we talked about this on the earnings call -- is an investment in data, making sure that we have real-time visibility and how we're performing against all the subcomponents of STARS. So that's why we feel like we can talk about the fact that we'll have ratable improvement against that long-term goal going into 2025.

Okay. No, that makes sense. To pivot over to one of the big positive announcements was the RFP around the PBM. So you've described it as exceeding your expectation. Can we drill down a little bit? And is that just pricing was better than you expected? Or are there other aspects to that agreement that you didn't contemplate going in that were, okay, we can do that with them and so forth, and that's part of the compelling nature of it? Maybe flesh out a little bit about where the exceeded expectations actually materialized.

Well, when we started the process, really, we started -- Sarah and I started meeting with the leadership of all the candidates in Q1 of this past year or Q1 of this year. And at that time, it's our job to convince other parties that we're serious, and we are willing to make a move if it's attractive enough. If the package of not just economics, but quality health and execution, if that whole package and partnership is attractive enough that we would move. So you really don't know about the competitive dynamic until you commence the RFP process. And we were pleased with the thirst of other parties to bid against the incumbent. And we proved to the market that we are willing to move if there's a meaningful enough difference in the opportunity on behalf of our members who have cost sharing and then our federal state customers. And then obviously, we, as the payer sort of pick up a benefit also.

Okay. And it's a 5-year deal. I know a lot of PBM contracts are 3 years. Yours is massive. So maybe that was just natural. You don't want to be moving this every 3 years, but any -- from your perspective, thinking around that, what made you willing to go for the 5 years? Are there price checks in there and so forth that would be somewhat protective if the environment changes dramatically? Give us some flavor for that.

Well, we mapped out the 5 years, but I view it as a 3-year deal in terms of the protections that we have. We hope to be -- you don't want to move PBMs that often. The last time we did it was to Caremark 8 years ago. So we'll have an 8-year contract. Before that was Catamaran and all their predecessors. So it's highly likely, and it should go 5 plus, but there -- believe me, there are protective mechanisms that protect our shareholders if our partner doesn't deliver. We totally expect them to but we have to put in safeguards, and we did so in this contract.

Right. I'm thinking more about even changes in the marketplace because that market, especially -- now especially can -- growing so fast can change. And that was the long-term issue with Anthem. Because they didn't feel like -- they were protected in that, but it sounds like you have protections there as well on that side.

I think we've gotten pretty sophisticated at knowing all of the different areas where we need to have checks and balances and all of that -- that was part of the rigor of the process was making sure those are really well integrated, to Drew's point, so that we have those layers of protection.

And did you expand what you're doing with the new contract versus what -- I mean is there more aspects to that around specialty drugs or anything else that wasn't incorporated in the original -- the RFP that's -- or the contract that's winding down on the new one now that you guys would highlight? Or are you bringing more services into the mix or anything?

There's always innovation that changes to some degree, and there's opportunities. But from a PBM services standpoint, it's in the zone of consistent in terms of the delegation of duties. I would say, to your point, A.J., as you learn from the past and whether it's your past or other people's past, you put in safeguards, and you establish joint rights to go to the market together in some cases so that you've got complete visibility into cost structure. So there are some elements that are enhanced. But largely from a fundamental standpoint, it's the same sort of suite of services.

And there's been discussion about this sort of $200 million transitional number. How, from a Centene perspective, should we think about that? Is -- if you didn't switch, you wouldn't have transitional costs. So maybe the $200 million is just offsetting costs you're otherwise having because you're transitioning it, maybe there's a potential for that to create some upside for '23. How would you have people thinking about that?

I think that's really meant to cover the transition costs, which are nontrivial. And the way we've thought about it in terms of the -- we've talked about platform consolidation and sort of the backlog of technology work that we have to do. We're using this actually as an opportunity to simplify the back end of the underlying pharmacy technology because it had become complex with multiple instances of Caremark over the years. So it's been actually a great opportunity for us to think about refactoring the technology road map, but those costs is very typical for the vendor to cover those costs. And they're pretty -- we're both pretty disciplined about making sure that they are really focused on just the migration costs.

Okay. Okay. You talked about the ongoing streamlining and -- programs. Where are we at in that? What's left to be done? You've got some things you've announced deals on. You haven't realized the cash on that. Just remind us where that stands today. And how much do you think you might end up taking in? And is that still going to predominantly go to buybacks and the future influx of cash? Or is it going to be now directed towards some of those other stuff?

So in terms of operational streamlining, I think we've made good progress in 2022 across a targeted number of core functions. And that was really meant to -- you need to do these things in thoughtful waves because otherwise, you overburden the organization with change. So it's really meant to take a couple of the key areas, put them through the first wave of transition. As we said, the benefit of that would really start to be seen in '23 and '24. But I think the other sort of now spoken benefit is that we can do this. And so part of the work that the VCO is doing, and we'll talk more about it at Investor Day, is then what we put up next on the docket in '23 in terms of regionalizing, standardizing processes, streamlining what we see in terms of efficiency potential because of that.

And I guess I was also thinking about asset sales and what you're doing to get rid of noncore assets. What still -- you've got some announced deals, which haven't gotten closed on. So that's proceeds to come in. And then there's a few other -- I think it sounds like there's still a few other things even beyond that, that may be on the table to look at. What do you think the intake of cash on all that might be? And is that still targeted for share repurchase mostly? Or what are you thinking on that?

You want to talk about capital deployment? There's still more in the portfolio, and we're going through the same process and I think making sure that those all have a good strategic position either to support the core business as an owned asset or under the ownership of a better oversight.

And we've done a little bit of delevering. I mean we bought 370 million of our bonds back for $300 million. So a nice yield we got on those, but largely share repurchase. We've bought back over 3% of the company. So you talk M&A, we're acquiring a really good company. We're acquiring Centene, buying ourselves. We're still looking for middle of the fairway type of bolt-on acquisitions. So we're not out of the acquisition game by any means. It's just we've got a lot on our plates in terms of mega transactions to seize the value creation opportunities with what we've got. And so those -- so that leaves you with buying yourself quite a bit.

Okay, okay. And how much is announced deal proceeds yet to come in, roughly?

I said Magellan Rx, we should net after tax $1.1 billion-ish. And the European hospital was pretty immaterial.

Okay, okay. Just to be fair, anybody have a question they would like to ask, in the audience?

We have 15 seconds left.

Yes. The transaction to buy in some of your public debt is interesting, and we've seen a few other companies pursue that. Is there any restrictions on your ability to do that, I don't know, covenant wise? Otherwise, anything that puts a restriction on that? And is that something that there was just an opportunity there? Or is that something you're actively looking at as an ongoing basis? Soon as I say that, your debt is going to go back to par on the...

And we're out of time. So I don't have to answer that. We look at our portfolio of debt. We've got a term loan also that would come due in '26 that we could chip away at as well.

Okay. Interesting. Okay. Great. Well, we really appreciate the management from Centene, Sarah and Drew, for participating in the conference today. That's great. And let me just make sure I have -- the next up in this room will be HCA. So thanks, everyone.

Thank you.