Humana: Medicare Advantage Will Never Be As Profitable As It Was (NYSE:HUM) (2024)

While most stocks have steadily risen, specific industries have been stuck in years of stagnation. The healthcare sector, led by insurance stocks, has faced chronic underperformance. For example, the iShares U.S. Healthcare Providers ETF (IHF) has not risen since 2021, as the insurance industry struggles with increasing costs and stagnated premiums. Humana (NYSE:HUM) has faced large pressures among the major firms, losing over 30% of its value since last fall.

Of course, Humana and others performed very well after the healthcare reform changes last decade. HUM rose by around 10X from 2010 to 2020, so its current weakness may be a natural result of its excessive performance in years past. Like many others, the company had very strong profit growth post-ACA as premiums skyrocketed. Today, the opposite is true, as premiums and government benefits are not rising as fast as medical costs, particularly when demographic and health factors are causing those costs to increase very quickly.

Can Humana Continue to Grow 2010s Style?

For the most part, analysts take a bullish view of Humana, with a slight bullish consensus surrounding it due to its perceived low valuation. Indeed, it is much cheaper than it was in the past. Further, many on Wall Street expect its EPS to recover in 2025, potentially rising to $40 or higher by 2028. There is just one Wall Street analyst projecting Humana's EPS into the 2030s, but that person estimates its EPS will be ~$83.6 in 2033, or over 5X above the 2024 expected EPS. This projection is also based on an anticipated near doubling of its sales by then.

HUM would almost certainly be undervalued today if we took to this outlook. This projection assumes its current pressures are transitory and will soon return to its previous growth trajectory. Many analysts seem to share this sentiment, primarily based on the paradigm after ACA. While theoretically possible, I take issue with this outlook. For Humana's income to rise, healthcare costs or utilization of benefits will decline, and/or premiums or significantly increased government funding.

Humana's core issue today is relatively simple. Around 88% of its revenue comes from Medicare, most of which comes from individual Medicare Advantage. These programs are focused on Part C and Part D, which are privately and publically funded. Problematically, the government is reluctant to raise spending on Medicare, and regulators are seeking to keep funding for Humana's programs flat. More broadly, government reserves for Medicare funding are falling and are expected to run out by 2031 without a significant increase in government funding. This issue is exacerbated by the fact that physicians are also reluctant to work with Medicare as reimbursem*nt rates fall below market rates.

Put simply, the Medicare health insurance model is not sustainable, particularly when the larger generation of older Americans is projected to surge into Medicare eligibility throughout this decade. Further, health status has declined significantly for many since 2020, as seen in the life expectancy decline. Heart disease, alcohol, cancer, and other issues have all increased markedly since then, leading to a significant rise in excess mortality that is not directly attributable to the pandemic (though COVID-attributed deaths represent a large majority in many government studies).

I believe decreased health status is likely a significant cause for the sharp increase in Humana's utilization rates, the main driver of its rising costs. Humana's margins are very thin, so a small "surprise" increase in utilization can significantly decline its profits. See below:

The consensus view is that Humana's margins will recover by 2025 to 2026 (according to its managers) as it raises premiums to match increased utilization. This issue also depends on government regulatory funding decisions. Of course, increased funding would accelerate declines in the Medicare reserve, creating an even greater need for improved budgeting for Medicare. This may be very difficult, considering its deficit is seemingly widening again (after closing from 2021 to 2023) due to increased interest costs and stagnating tax receipts.

In my view, Humana's business model is problematic because it is so focused on Medicare, which may carry the greatest political risks and economic and demographic issues stemming from population inversion, rising healthcare costs, and deteriorated US health status. Humana theoretically has the means to push these rising cost factors onto individuals. Still, I expect it will continue to face significant funding pressures as healthcare costs seem to grow faster than incomes, which is unsustainable.

The company's decision to focus primarily on Medicare is a logical choice that has likely allowed it to lower operating expenses to sales. However, it has struggled to keep this margin pressure contained since 2020. See below:

Reducing its operating overhead is likely the most reasonable way for Humana to see a marked rise in profit margins. Humana has pursued some layoffs, with Centene (CNC) and UnitedHealth (UNH) also doing layoffs associated with Medicare Advantage pay reductions. Humana is essentially burrowing into a market (Medicare Advantage) that many peers are looking to move away from due to its declining profitability. Theoretically, that should allow Humana to have lower operating costs as it faces less competition. Still, it puts Humana at significant risk, given it is becoming so embedded into a precarious situation with, in my opinion, a highly unfocused regulatory and legislative environment that is not necessarily keen on solving the core healthcare issues, even as those issues accelerate.

The Bottom Line

I think it is reasonable to assume Humana should see a natural improvement in its profit margins by 2025. However, I would be surprised to see its margins rise to much over 2%, given the continued and potentially accelerating pressures that I expect will push costs and utilization up on Medicare plans. Further, I do not necessarily expect the government to increase payments toward Humana substantially. However, that may depend on how this election goes and whether either party pursues significant healthcare reform actions. Because significant healthcare reform (resulting in lower premiums) has not been accomplished despite needs, I do not expect that to occur until a crisis happens (such as Medicare losing its funding reserve).

Humana has placed itself in the crossfire of this mess. Between rising healthcare spending and premiums growing faster than incomes, I do not think regulators will be particularly concerned about ensuring Humana's profit margin rises back to 5%. Indeed, lower profit margins in the healthcare sector are essentially an inevitability of this crisis, although I do not expect Humana to sustain levels below 1%, with 2% seeming most likely.

So, I project Humana's margins at a steady 2% but agree with other analysts that its sales will continue to grow quickly due primarily to increasing Medicare eligibility numbers. Its sales consensus outlook is $160B by 2030, which seems reasonable given the demographic trend. At a 2% margin, that translates to ~$3.2B in income (by 2030), which is around its 2020-2021 peak level. Under this view, HUM is likely overvalued, having a forward "P/E" of ~20X for the coming three years.

I would not bet against Humana, although my outlook is bearish. I think it has the potential to rebound as the company should see a recovery in its margins and may offer improved guidance. However, when we look at the broader situation facing Medicare, it seems very unlikely that the 4-5%+ profit margins of the 2010s will ever permanently return. To me, the previous level of profitability of MA plans was based on a temporary market opportunity created by ACA. In other words, in the years following ACA, there was widespread opportunity and lower direct competition as the market adjusted to the new situation. In the future, regulation, competition, and economic need for lower premiums will likely push Humana into a new normal of lower profitability on those government programs.

Harrison is a financial analyst who has been writing on Seeking Alpha since 2018 and has closely followed the market for over a decade. He has professional experience in the private equity, real estate, and economic research industry. Harrison also has an academic background in financial econometrics, economic forecasting, and global monetary economics.