Legg Mason Vet on the Future of Obamacare
By: SumZero Staff | Published: November 17, 2016 | Be the First to Comment
Earlier this week, Dale Wettlaufer, Founder/PM of Buffalo, NY-based Charlotte Lane Capital, published a 12-page thesis recommending shares of hospital giant HCA Holdings (HCA:US) on SumZero.
The heavily-researched thesis on HCA goes into a detailed interpretation of the future of the Affordable Care Act (ACA), aka Obamacare, and the broad, downstream impacts on relevant sectors. We sat down with Wettlaufer for a Q&A to learn more.
Dale Wettlaufer is the CIO / CEO of Charlotte Lane Capital, which emerged from a large asset manager in 2016 after incubating the strategy for 7 quarters. He has has 16 years of professional money management experience, including 11 years with Legg Mason Capital Management, where he was an analyst, PM, and Consumer & Real Estate sector head.
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SumZero: What is the future of the Affordable Care Act (ACA), aka Obamacare, under a Trump presidency?
Dale Wettlaufer, Charlotte Lane Capital: I believe Medicaid expansion will survive while State Health Insurance Exchanges have some bad adverse selection problems right now. Those can be ameliorated with a national underwriting pool and clearer risk sharing support for the Exchanges. Penalties for non-enrollment should go to the underwriters, not the US Treasury; otherwise the adverse selection problem remains.
A number of State exchanges are running on fumes and this is hurting middle income people the most. It’s no surprise that group was Trump’s biggest supporters. The two lowest income quintiles represent the biggest swing towards the GOP vs. 2012 and benefit most from Medicaid expansion. I don’t think Mr. Trump and the GOP will throw overboard these cohorts. I believe the overall thrust of ACA will remain with a re-ordering of some key financial elements.
SumZero: What is the opportunity with HCA Holdings (HCA:US) stock right now?
Dale Wettlaufer, Charlotte Lane Capital: HCA has grown its business under a cloud of regulatory worry since the inception of the Affordable Care Act six years ago. Will it ACA be repealed? Will ACA harm the sector? The Act has faced a number of tests, including at the Supreme Court level. While HCA’s revenue grew 60% and EPS grew 250% from 2008 through 2015, the multiple on the stock compressed and stands at 11x 2016E consensus EPS because of the overhang.
I argue ACA or broad healthcare access won’t be repealed, based on what President-Elect Trump and members of Congress have said, based on my read of how a social democracy works, and based on my read on the political consequences of a such a repeal for the newly-unified government under the GOP. I also argue it’s inconsequential for excess return potential in HCA from this point. Remove ACA and it gets re-rerated. Modify ACA and it gets re-rated.
SumZero: Why now?
Dale Wettlaufer, Charlotte Lane Capital: HCA was down 16% the day after the 2016 national election. It has recovered somewhat, but was already cheap because of the overhang. It has traded off on adverse headlines and the stock has been over the last 18 months jumpier than a long-tailed cat in a room full of rocking chairs. I believe the long-term growth outlook of the company and its competitive position are highly attractive with or without ACA and this point of heightened fear in the stock has improved the expected excess return in the stock.
SumZero: How will a Trump presidency impact the future of the industry?
Dale Wettlaufer, Charlotte Lane Capital: Mr. Trump has clarified his position on ACA to mean he intends to replace ACA, with no pause in coverage, vs. repeal it outright. I believe his Administration and Congress will want to work toward a more fluid national underwriting structure for manage care organizations as well as better-evolved market solutions to cover lower income Americans and middle class entrepreneurs who are not strong bargaining units in the public and private marketplaces.
This would be great for HCA, as it has the lowest unit costs in the industry, has 25% market share across its metropolitan areas, produces a 13.5% ROIC, and would benefit from a further decline in industry capacity as less capable competitors drop off the map in a tougher payer environment.
SumZero: What is the market missing? What's your variant view?
Dale Wettlaufer, Charlotte Lane Capital: The market will at times price in the most prominent negative salients in a stock, at times in multiple ways. For beloved stocks, the more prominent positive salients can get discounted over and over. It’s just the nature of momentum and herding. This is a high quality company in a tough sector, which is just right for my tastes and experience.
My variant view is the franchise is stable, they invest behind it, and ACA / broad healthcare access isn’t going anywhere. If it is, that’s 6.5% of EBITDA gone and it’s still cheap. Which would be dandy for me – this would be a staple-like company trading at about 12.5x earnings, at a 7-8% FCF yield, with secular growth tailwinds, with 12%+ post-ACA ROIC, and high incremental returns on capital. If this company made ketchup or soda, it’d be trading at 20x earnings or better. What’s more predictable, Heinz ketchup sales or heart attacks and the inevitable completion of the circle of life for us all?
SumZero: Why is HCA the right choice versus others in the healthcare industry?
Dale Wettlaufer, Charlotte Lane Capital: This has the market share to stand up ably to payers, to attract the most capable physician groups in each metro area, and to grow earnings, cash flow, and returns as the country ages. Other competitors in publicly traded acute care firms don’t have the cost structure or market share that matches HCA’s and don’t have the business lines HCA’s scale affords it. It’s cheap and high quality. Some value people like the cheapest, lowest-quality home run potential names in a sector. I’ll do well with the quality outfit as there’s some financial leverage that provides afterburner thrust (though HCA’s leverage is not out-of-line with the industry on leverage).
SumZero: What needs to happen for your thesis to work-out?
Dale Wettlaufer, Charlotte Lane Capital: I need the GOP to either dump ACA and let us go on without the overhang or I need them to modify ACA / broad healthcare access and allow us to evolve in that environment. If the latter takes place, great. The GOP would then own broad healthcare access as much as the Democratic Party has owned ACA and the legislation becomes entrenched. Ideally, I’d like to own this as the earnings grow and the multiple expands in recognition of the franchise and the lower risk. I look forward to mutual funds (which has been my background and where this is vastly under-owned) taking this off my hands at 15-20x EPS 3-5 years out.
SumZero: Are you hedging the position?
Dale Wettlaufer, Charlotte Lane Capital: No. I have a position in this and the top publicly traded electronic health record company, Cerner (CERN). I don’t have any direct or indirect hedges on.
SumZero: How does the position fit into your overall investment strategy at Charlotte Lane?
Dale Wettlaufer, Charlotte Lane Capital: I’m a deep value investor by background and this is a familiar sort of position for me. It has leverage on it, which kind of goes hand-in-hand with much of my deep value experiences, but the credit structure is well done. I also lean toward firms with family or insider involvement, with hard capital on the line (vs. soft stock compensation capital on the line). The founding Frist family has an 18%+ interest and has IPOed this three times (the initial IPO was followed by two LBOs and two IPOs in the last 20 years).
There is complete alignment between passive minority shareholders and active principals, in terms of capital allocation and in terms of investing for long-duration competitive advantage. This is Charlotte Lane’s top position, at 7.2% long within a 23% net long portfolio. It will play a large part in determining my clients’ outcomes with Charlotte Lane, I believe positively.
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