We reiterate our Neutral recommendation on the shares of CIGNA Corp. (CI). Though the company is strongly poised to record earnings growth, given a number of strategic investments undertaken for future growth, volatility associated with its discontinued guaranteed minimum income benefit (GMIB) business and its pension burden keeps us on the sidelines.
Acquiring HealthSpring Inc. has instantly made Cigna a big player in Medicare Advantage, the U.S. health plan for the elderly and disabled, a market where it was virtually non existent. Cigna was unenthusiastic about entering the segment since it lacked the expertise and did not see a clear path to winning customers. However, the HealthSpring model lends itself to focus on the elderly population and makes targeting the ABD (aged blind and disabled) population more feasible.
The acquisition is expected to triple the number of Medicare customers it serves to 1.75 million. Medicare is the most sought after market as 75% of the seniors in U.S are covered directly by Medicare. The segment holds immense potential as the first tranche of baby boomers (people born between 1946 and 1964) enter their retirement years, making 7 million Americans eligible for Medicare in the next five years.
Cigna has witnessed a membership growth of 2%. For the past one and a half years, the company has registered a continued uptick in demand for its administrative services only (ASO) products (contributing 80% of total membership) as well as incentive and engagement-based programs. We expect the uptrend to continue in 2012 as the growth in medical premium taxes influences more employers to consider self funding. Management expects to witness significant customer growth in 2012. It anticipates full year 2012 membership growth of approximately 900,000, driven by organic growth and the addition of customers through the HealthSpring acquisition.
Cigna is aggressively expanding its international business (contributes approx 10% of the revenues), which has historically delivered double-digit revenue growth and double digit earnings growth, with very attractive margins and capital efficiency.
The company also boasts of a solid balance sheet, which continues to grow with its strong operating earnings and cash flow generation. The company ended fiscal year 2011 with $3.8 billion in cash and investments available to the parent company and expects to have a total of $900 million to deploy in 2012. Management wants to deploy excess capital for selective acquisitions, reinvestment in core businesses and share repurchases.
Despite the positives, Cigna will continue to see earnings volatility related to its discontinued GMIB business. An above average concentration of commercial mortgage loans and real estate loans, to the tune of approximately 15%, in its total investment portfolio also remains a cause of concern.
Cigna also has considerable under funded pension liability on its balance sheet compared to its peers Aetna Inc. (AET), and UnitedHealth Group Inc. (UNH). If interest rates remain low for a prolonged period, pension expense will continue to dampen earnings per share.
Cigna currently retains a Zacks # 3 Rank, which translates into a short-term ‘Hold’ rating.
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