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WellPoint, Inc. (WLP): The Mysterious Undervaluation of Health Insurers

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WellPoint, Inc. (NYSE:WLP)If you think Apple is undervalued, you don’t own a health insurer.

Yesterday, for instance, WellPoint, Inc. (NYSE:WLP) delivered a solid beat on earnings, $800 million or $2.64/share, and continued its $0.38/share quarterly dividend. In response the stock barely yawned, rising just two cents a share, yielding a Price/Earnings (P/E) multiple of 10.31.

WellPoint, Inc. (NYSE:WLP) has become one of the more undervalued big-cap stocks in the market, and within its industry it’s not alone. Most players trail the market in terms of their earnings multiples.

What’s going on and how can you take advantage?

Why Wellpoint is gaining

The main pain point is politics. Most investors are Republicans, yet WellPoint, Inc. (NYSE:WLP) and the other insurers are benefiting hugely from the Affordable Care Act of 2010, also known as Obamacare.

The act mandates wellness care, requires a certain percentage of premiums go to care, and prevents past practices like denying coverage for pre-existing conditions. These should be negatives, but as proponents of the law predicted, wellness care does pay for itself.

The truth is in WellPoint, Inc. (NYSE:WLP)’s latest earnings, released this week.  Net income was 19% higher than forecast, and the company said it was because of “lower than projected costs.”

This should not be a surprise. Since the “ObamaCare” law was signed, insurers have been grabbing at high-risk Medicare patients with both hands – Wellpoint itself spent $4.6 billion late last year to buy Amerigroup, which specializes in these types of people. And now it credits that acquisition with fueling its profit growth.

As the processes of handing Medicare patients, who have higher risks than the normal patient, filter down into the general market, the gains are going to only grow. Prevention actually has a bigger pay-off among younger patients. Avoiding obesity, limiting diabetes, and reducing heart attack and stroke have an enormous pay-off, and WellPoint, Inc. (NYSE:WLP) now has the knowledge to tap into it.

How are the insurers maximizing these profits? By buying groups that combine premium payments with control over clinics and hospitals. This is the model that has let companies like Kaiser and Intermountain Health in Utah under-price standard insurers for years. When you control both income and outgo, you have a financial incentive to keep people well, while if you only control income you don’t.

It’s really quite simple.

The political discount

It seems that investors like our own Dan Caplinger may not be looking at the full picture. By focusing on the ongoing problems of setting up state-health exchanges, which are subject to political pushback in Republican states, some are ignoring the financial benefits insurers are accruing now, and the additional benefits they’re going to accrue as more people get insured.

California, which is rolling out an exchange called Covered California, due to launch enrollment on October 1, is the test case. Conservatives are throwing everything they have against it, harping on every negative they can find, but 13 insurers have had rate plans approvedThe Sacramento Business Journal reports that these rates are as much as 29% lower than current rates with companies offering only insurance competing directly against Kaiser Permanente, which also delivers services.

But here’s the real bottom line. If WellPoint, Inc. (NYSE:WLP) is making a profit serving high-risk Medicare patients, using wellness services to reduce the risk of people going into hospitals, why is it assumed it can’t bring the same procedures to the larger insured market and make even more money? And if Medicare is such a bad deal why is it that a company specializing in such patients like Health Net, which even serves Veterans, is trading at a P/E of 32?

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