Highlights
CVS Health plunged a whopping 8% today Post-Market due to an announcement made by United Health Care Group on its managed care concerns. I quote this from the management guidance received from United Health. "I think one of those areas we commented about in the first quarter was outpatient care activity was the area there, where we saw higher level inpatient continued pretty controlled. Probably below 2022 levels, but outpatient levels have continued to be in an area that we've focused on most and where we see it occurring. It's mainly as you think that completing April, seeing May, and leading indicators in two weeks of June, would be continued strong outpatient care activity.
I think Hips, Knees, senior business, and cardio are kind areas and very localized in the Medicare business; we are mainly seeing them. Trend, there are some indications that it looks a little bit like a pent-up demand. Or delayed demand being satisfied. And there are some indications, what we see, we have insights into other areas, for example, our ambulatory surgery.
I think that would lead us to believe as you look at Q2, you would expect Q2 medical care ratio to be in the zone of probably upper bound or moderately above the upper bound of our full-year outlook in terms of where Q2 will be and then. I will expect that our distance in the entire year would probably settle in the upper half of the existing range so that we set up." In the following sections, I will highlight the keywords spotted in this quote to write about the relationship of the pent-up demand from elective operations, Aetna ambulatory surgery coverage, and how this mispricing can be exploited.
Medical care ratio
CVS Health Balance SheetWhat is this medical care ratio the management is referring to? In Healthcare-insurance, Medical Care Ratio is healthcare expenditure to improve healthcare quality and is primarily a ratio of the cost of premiums to the premium revenues. This is also sometimes referred to as the policy benefits or relevant items illustrated above in the picture. Medical Care Ratio = (Total spent on healthcare and quality improvement / Total premium revenues) x 100 The remainder of the benefits is typically used as marketing and administrative cost in the OPEX. Concurrently, it then flows to the bottom line to cashflow to be returned to shareholders as dividends or share buybacks.
CVS Aetna's Medicare coverage
Looking at the SEC statement (10-K) of CVS Health, it has vertically integrated AETNA, a healthcare insurance in a strategic acquisition.
Edit ImageAs illustrated, ASC footprint is widely covered in CVS Health's Aetna Compartment. This, along with the Medicare segment, takes up to 18,529,000 members out of 24,396,000 (75% of its premiums projected to be paid). An ASC (Ambulatory Surgical Centre) is a healthcare facility established to give surgeries and procedures that are not assured overnight hospital stay; this includes same-day procedures and outpatient movement. In other words, they are also "Elective operations," mostly, expensive operations performed that are usually not medically necessary, except in some cases. Given this, ASC is built to help save costs to dedicate to these requirements. At first glance, having a vast ASC component for CVS is terrible news, as the guided pent-up demand for elective operations will exacerbate the medical care cost ratio and may be a significant catalyst to send the operating margin plunging into the abyss.
However, I will elaborate on why we need not worry that much despite the 8% plunge PM.
Elective Operations and it's pent up demand
Having worked in a hospital (Healthcare sector) prior as a data analyst, I frequently evaluate elective operation cost, which is widely known for its hefty price tag. During covid lockdowns, many elective operations were postponed/delayed or stopped due to insufficient doctors and hospital beds for same-day surgery operations. Elective surgeries were deemed a luxury and unnecessary back then in these difficult times. Nonetheless, Elective surgeries, both medically necessary and unnecessary are popular and led to pent-up demand eventually after the covid-lockdowns in various countries. However, I evaluated the precarious scenario and believed the medically-necessary operations were still going on during co-vid times as those are desperate measures taken. Doctors and surgeons will gather and review the individual cases and tailor them accordingly. Some of these from my prior experience, namely important cases like tumor removal, are not likely to be removed or delayed. Unfortunately, the medically unnecessary and luxurious one will be held back till after covid scenario lightens up.
AETNA coverage for elective operations
We should pay attention to the fact that the pent-up non-medically necessary elective operations are of little concern to the ASC and insured segment of CVS Health as they are not widely covered under the plans.
Conclusions
To summarize, we should exploit this current mispricing of approximately 8% drop (Due to overreaction). This is overall a result of
1) Elective operations pent up from covid are the result of this abrupt drop in stock prices
2) The medically-necessary elective cases, such as cancer removal in the doctor books (from my prior healthcare experience), are most likely already completed in the queue for 2021 and 2022. This is proven by the gradual surge in 2021 and 2022 SEC (84 and 85%) cited in the above illustrations.
3) The non-medical necessary elective operations are rendered redundant as they are not widely covered in Aetna's insurance book despite the huge ASC and Medicare footprint in CVS Health Aetna.
4) I will write a more elaborate article on why CVS Health is at ts 52-weeks low and this is also another mispricing situation in recent events of Oak Street Health and Signify Health acquisition.
Trading Strategies
I proposed to long the share itself or long calls as an options play here as I am pretty bullish for the stock to regain its composure and rebound from this abrupt drop The Implied Volatility (approximately 26%) has also remained low for CVS Health, which is a good indicator of long calls as the IV of the stock is projected to go up due to rising uncertainty about how to deal with the company news.
I would like to believe plenty of people will be confused by this breaking news, not knowing whether to short or long the shares and its options.
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