March 28, 2019 - 1:17pm EST by
2019 2020
Price: 159.00 EPS 16.47 0
Shares Out. (in M): 380 P/E 9.7 0
Market Cap (in $M): 60,000 P/FCF 0 0
Net Debt (in $M): 39,000 EBIT 10,600 0
TEV (in $M): 99,000 TEV/EBIT 9 0

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Cigna is a diversified health insurance company trading at 10x forward earnings with expectations to compound EPS by 15% annually between 2018 and 2021:



Cigna has compounded revenues at 11% per annum between 2009 and 2018 and EPS at 15% over this time period, compared with 11% for the S&P 500.


Ultimately, we believe we have the opportunity to purchase a capital-light business trading at a 40% discount to the S&P 500 (forward multiple of 10x for Cigna vs. 17x for S&P 500). Cigna generates fee revenue in a stable sector that is growing EPS faster than the average S&P 500 company (CAGR of 15% for Cigna vs. 8% for S&P 500).


Company Overview


Cigna is a diversified health insurance company operating in four main segments: Integrated Medical Services, Health Services, International Markets, and Group Disability & Other.


Integrated Medical


The Integrated Medical Services is primarily composed of Cigna’s medical insurance business. Cigna’s primary business in this segment is commercial medical insurance—providing insurance to employer groups. Cigna also has a significantly smaller government business which includes mainly Medicare Advantage (Medicare administered by a private health insurance company, typically done more efficiently than the government) and a specialty business (vision, dental, etc). The vast majority (85% of Cigna’s commercial book) is fee revenue (similar to a licensing software but no capitalized development costs) by allowing employer groups to license Cigna’s network of doctors. (The employer groups then underwrite the risk of insuring the employee and are responsible for the medical costs).


Health Services


The Health Services division primarily provides pharmacy benefit management for customers. The majority of this division was a result of Cigna’s acquisition of Express Scripts, a pharmacy benefit manager, in March 2018 (closed December 2018). A pharmacy benefit manager is essentially similar to a group purchasing organization. In addition to providing several fee-related services, a PBM mainly allows customers to receive discounts on drugs because they are purchased in bulk. Similar to Integrated Medical, the health services division generates fee revenue by allowing employer groups to license the companies network.


International Markets


Cigna’s International Markets segment operates in over 30 countries and provides comprehensive medical and supplemental health, life, and accident benefits to individuals and employers. Products and services include comprehensive health coverage, hospitalization, dental, critical illness, personal accident, term life, and variable universal life.


Group Disability and Other


This segment provides long-term and short-term disability insurance, group life insurance, and other products.


The Opportunity


The opportunity to buy Cigna at 10x forward earnings is a result of three reasons:


  1. Elimination of PBM rebates and drug pricing pressure;

  2. Recent proposals for “Medicare for All;” and

  3. Cigna’s leverage.


Drug Price Risk


One of the ways that Cigna’s PBM business earns revenue is through rebates provided to them by drug manufacturers. A second source of revenue is from earning a spread on the drug prices themselves.


1) Rebates


For those unfamiliar with the rebate issue, this article provides a good summary:

Regarding this issue, Cigna’s CEO on the Q4 2018 earnings call stated: 


“The headline #1 is, the proposed rebate rule will not have a meaningful impact on our growth or earnings trajectory. Specifically, as you noted, the proposed rule, as will be evaluated over the next 60 days, applies to Medicare Advantage and PDP. The mechanisms that exist in terms of the way rates are built up for Medicare Advantage as well as PDP largely by design, flow and respect the rebates and pass-through the way the rates are built. And so we don't see a major implication to that business portfolio. And then inferred in your comment, it does not apply to the commercial marketplace. We do see some opportunities in the proposed rule as articulated. For example, it provides the mechanism to even further accelerate value-based care programs with the pharmaceutical manufacturers. You'll recall from the day we announced our proposed combination on March 8, we talked about that as an important initiative that we passionately believe in. This will provide some further accelerance to that as well as potentially open up some additional chassis to work with pharmaceutical manufacturers to get better alignment. But the big picture, we do not see it having a material effect on the business portfolios configured and are on track to deliver the 17% to 20% EPS growth in 2019.


Even if the rule were extended into the commercial market, we believe that companies like Cigna would simply have to change their plan design to offset this. Express Scripts and CVS already pass along the majority of their rebates to clients:


Express Scripts returns on average 90% of rebates we negotiate with drug manufacturers directly to our clients. Our clients, 100% of the time, decide how rebates will be returned to them. In turn, clients determine how they will use rebates to lower patient premiums, cost-sharing, and/or deductibles.”


“We return over 95% of rebates to commercial clients and their members. For Medicare Part D plans, effectively 100% of the rebates are passed through to help lower premiums, which reduce costs for both the beneficiary and the government.“


Earlier this year, CVS said it keeps just 2% of rebates, and disclosed that it expects to make $300 million on drug rebates in 2018, amounting to 3% of its annual earnings. Beckerman said the company does not expect CVS Health’s profitability to increase or decrease as a result of the shift to 100% pass-through rebates.


This was reiterated on the Q4 Call:


Justin Lake Wolfe Research, LLC:


Okay. Then if I could just sneak in my question on rebates. Express historically put out a number of $400 million. I know you don't think it all goes away with commercial and all, but can you give us an update there, worst-case scenario, if rebates go away, where do you think that would be? And any comments, CVS put out some discussion around rebate guarantees being effected by inflation. Anything there that you see as a headwind for '19. Those 2 things would be helpful.


David Michael Cordani President, CEO & Director:


Justin, it's David. You've effectively put in about 4 questions. Let me try to wrap a couple of them together. First, specific to the commercial side of the equation. As noted previously, the rebate rules articulated and proposed does not affect the commercial market. As you go back -- you're correct, let's go back and use the numbers that were put out. First, for Express Scripts, about 95% of all rebate discounts, et cetera, are passed back. Second, per prior conversation, about 50% of all clients within Express Scripts opt for today full pass-through rebate models. That covers importantly about 2/3 of the volume, so there's a little disproportionality of that. The net of that is we have multiple funding mechanisms already in hand today and aligned payment models that work for clients across the commercial, health plan and government agency sector that work for them and work for us to get levels of alignment and we'll continue to evolve those over time. Specific to the rebate guarantees, you'll note that we did not call that out as a headwind. Stepping back, our industry, broadly speaking, has guarantees as a part of it, whether that's in the formal nature of a guaranteed cost offering, a discount guarantee, a rebate guarantee, a trend guarantee or otherwise. And both legacy organizations have a great track record of effectively gaining alignment and managing those on a go-forward basis. Lastly, I would just add that Express Scripts had some visibility into the decelerating trend environment and as such took appropriate actions with their services contracts. So again, we have not called that out as a headwind.


Analysts at Fitch wrote:


Those changes could be “disruptive” to current business models, according to Fitch. New net pricing models could take some heat off the industry, they added, but it’s not likely to materially change the amount of money that flows through those business lines.


“We believe it is unlikely CVS and Cigna would forego [sic] drug manufacturer rebates without a corresponding offset of higher fees on other services,” they wrote. “Even if rebates or other forms of spread pricing are used, the PBM operations of CVS/Aetna and Cigna/Express Scripts are expected to comprise a material amount of projected pro forma cash flows for the combined CVS/Aetna and Cigna/Express Scripts companies.”



2) Drug Price Risk


Although there are headlines around high drug prices and fear of a substantial decline in drug prices, the reality is that drug prices have been growing at a slower pace than inflation for decades. Nevertheless, Express Scripts has managed this issue for many years while growing revenues and profits. We anticipate either slight increases or decreases in drug prices over time, but we do not expect this to have a material impact on the cash flow or value of its PBM business:


Prescription Drug Inflation 


Overall Consumer Price Index



Many people do not understand what value PBM’s offer in the supply chain and thus believe the Express Scripts is essentially a legacy business model that will get disintermediated. However, Cigna’s peer, Anthem, is currently organically developing their own PBM, ingenioRX, from scratch. Centene, another competitor, is also pursuing this strategy by creating their own PBM called RxAdvance. This is an indication to us that PBM’s will continue to operate and provide value for its customers in the future. This business model is not being permanently disrupted even though the current valuation at 10x earnings assumes the business will see no future growth.  


3) Medicare for All


In early March 2019, a bill was established by Rep. Pramila Jayapal proposing Medicare for All. As a result, health insurance stocks fell by ~10-15% with the fear that Medicare for All would disrupt the managed care ecosystem. We believe that this is an overreaction to a low probability event for several reasons:


  1. Democrat House leadership have opposed Medicare for All. Taking away employer based insurance that over 150 million Americans currently have seems unfeasible. This article provides color on Nancy Pelosi’s view and relationship with managed care organizations:


This is an idea that if we had a tabula rasa, if we were just starting clean, would be the most cost-effective way to go forward. We don’t have that,” she said. “Over 120 or 150 million people in our country have employer-based access to their health coverage and insurance.” At the time, her objection to Medicare for All was that it distracted from the fight to defend the ACA, which Republicans were trying to gut. “So right now, I’m going to be crude. Now we’re in my living room, so I can be crude. It isn’t helpful to tinkle all over the ACA right now,” Pelosi said. “Right now, we need to support the Affordable Care Act and defeat what the Republicans are doing.” At other moments, she has said that single payer isn’t popular, arguing, also in 2017, that “the comfort level with a broader base of the American people is not there yet.


The third ranking Democrat, Frank Pallone also reiterated this view:


Pallone also said House Democrats plan to focus on shoring up Affordable Care Act provisions rather than enacting a "Medicare for all" policy of the kind backed by Sen. Bernie Sanders, I-Vt., and other Democratic presidential candidates. He said enacting change within a deeply divided Congress would be nearly impossible.


2) On March 26th, 2019 the Democratic Party revealed their official healthcare plan which they will push during the elections: The Protecting Pre-Existing Conditions & Making Health Care More Affordable Act of 2019. We believe this plan will be a benefit to health insurance companies as it provides more subsidies and coverage to lower the uninsured rate. This plan, supported by leadership, is in stark contrast the ultra-left Medicare for All bill. The details of the plan can be found here:


3) Senate rules make it difficult for Medicare for All to be passed. Medicare for All would first require Democrats to win the House, Senate, and Presidency. Moreover, Medicare for All could not get passed under budget reconciliation and as a result would require 60 votes in the Senate to get passed. Currently, polls indicate that the Republicans are likely to keep the Senate in 2020 and even if they lose, there is an extremely low probability they lose 60+ seats.


4) Cost. It is estimated that Medicare for All would cost the government ~$30 trillion over the next decade which we believe is unsustainable for a government already facing extremely high deficits and other entitlement obligations.   


We also believe that lowering the age for Medicare buy-in would be difficult given that the Medicare trust fund is already set to be depleted by 2026. How do you expand coverage for a program that is already about to go insolvent?


We do not believe Trump’s potential repeal of Obamacare will have a material impact on Cigna or the margin of safety embedded in the stock given the company’s focus on commercial insurance and less on government managed Medicaid.




Because of Cigna’s acquisition of Express Scripts, the company levered its balance sheet to 4x debt / EBITDA. Over the next couple of years, Cigna will delever its balance sheet to a more normalized level in the mid-2’s.



As this happens, we believe Cigna’s P/E multiple will expand closer to its commercial peers: UnitedHealth (with a PBM) and Anthem (who is in the process of developing a PBM):




As Cigna executes on its plan, de-levers its balance sheet and achieves its $20-21 in EPS in 2021, we believe Cigna’s equity value and P/E will increase and trade closer in line to its peers and historical average.


Using the mid-point of Cigna’s 2021 guide and a 17x LTM P/E multiple (still in line with S&P 500 multiple when these businesses used to trade at premiums to the market, given the capex light, fee nature of their businesses, and faster the market EPS growth), Cigna would be a $350 stock in 2021. This represents a 30% IRR over three years from today’s price. Discounted back 2 years at 10% implies that the stock should be worth $290 by the end of this year or ~80% upside to today’s price at $160.  

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


- Growth in EPS,

- Pay-down of debt

- Perceived political risk is realized to not be a reality

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