ALHC - Alignment Healthcare: Still Spending $106 To Earn $100 In Revenues
2023-08-11 17:17:43 ET
Summary
- Alignment Healthcare is a health insurer targeting seniors. The company has shown exceptional growth, compounding membership and revenues at 20%+.
- However, I have concerns about the company's profitability, as the Medicare Advantage business it targets has capped profitability and Alignment have yet to show its ability to scale SG&A.
- Despite a beat to consensus in Q2/2023, Alignment's profitability has further deteriorated, and its business model continues to be unprofitable.
- I continue to recommend investors avoid ALHC.
A few quarters ago, I wrote a cautious initiation article on Alignment Healthcare ( ALHC ), noting that Alignment has capped profitability with no evidence of economies of scale.
With shares of ALHC declining by over 45% since my article and the company recently reporting an earnings beat , let us revisit the story to see if my views on the company has changed (Figure 1).
Figure 1 - ALHC shares have tanked 45% since my cautious article (Seeking Alpha)
Brief Company Overview
First, for those not familiar, ALHC is a health insurer targeting seniors. Alignment partners with local providers to deliver high quality, affordable care that is tailored for its plan members. Alignment's operations primarily consist of Medicare Advantage Plans in California, North Carolina, Nevada, Arizona, Florida and Texas.
Since starting in 2014, Alignment has grown at a fast pace, with over 100,000 in-plan senior members as of January 2023 and operating across 52 counties in six states (Figure 2).
Figure 2 - Alignment has scaled to over 100,000 members (ALHC presentations)
Within the six states that Alignment operates in, the total addressable market is 8.3 million seniors, so it appears Alignment still has a lot of growth runway (Figure 3).
Figure 3 - Alignment has a large TAM (ALHC investor presentation)
Strong Growth But Poor Profitability
There is no question Alignment has delivered exceptionally strong growth since its founding, with membership and revenues compounding at 20% and 21% respectively from 2020 to 2022.
However, my main concern in my initiation article was Alignment's lack of profitability. Specifically, Alignment had recorded H1/2022 Medical Benefits Ratio ("MBR", similar to a gross margin figure for health insurers) of 85.1%, about as low as regulations would allow (Figure 4).
Figure 4 - ALHC had 85.1% MBR in H1/22 (ALHC investor presentation)
Yet, the company was not profitable, since SG&A ate up more than 15% of revenues. As seniors became more comfortable with life post the COVID-pandemic, they were likely to take up elective surgeries that were postponed during the pandemic. So Alignment's MBR ratio was likely to increase, hurting profitability even further.
My initial assessment proved to be correct, as Alignment ended 2022 with a full year MBR ratio of 86.5%, meaning profitability declined as the year progressed (Figure 5).
Figure 5 - ALHC 2022 MBR was 86.5% (ALHC 2022 10K report)
Furthermore, even adjusting for stock-based compensation, Alignment still ended 2022 with an adj. EBITDA loss of $26.7 million, suggesting that it was still spending too much on SG&A relative to its revenues (Figure 6).
Figure 6 - ALHC recorded an adj. EBITDA loss in 2022 (ALHC 2022 10K report)
Q2/23 A Beat To Consensus But Still Losing Money
Fast forward to the company's latest Q2/2023 earnings , Alignment actually surprised to the upside, recording revenues of $462 million, $24 million ahead of consensus, and EPS of -$0.15, $0.07 ahead of consensus. Has Alignment's business finally turned the corner on the path towards profitability?
Unfortunately, I believe the answer is no. Studying Alignment's 10Q in more detail, we can see that Alignment's MBR ratio further deteriorated since the end of 2022, with H1/2023 MBR of 89.0% vs. 85.1% YoY (Figure 7).
Figure 7 - ALHC H1/23 MBR was 89.0% (ALHC Q2/2022 10Q report)
Furthermore, even adjusting for equity compensation, adjusted EBITDA declined YoY in the first half to an adj. EBITDA loss of $7.2 million from a profit of $6.4 million in H1/22 (Figure 8).
Figure 8 - ALHC recorded adj. EBITDA loss of $7.2 million in H1/23 (ALHC Q2/2022 10Q report)
Importantly, on a percentage basis, Alignment's business model continues to be unprofitable, as total expenses (medical + SG&A) continued to exceed revenues by a wide margin (Figure 9).
Figure 9 - ALHC expenses continue to exceed revenues (ALHC Q2/2022 10Q report)
Insider Selling Abated For Now
Since my early October article, insiders continue to be net sellers of ALCH shares, with 49 insider sells for $369 million vs. a single buy for $660k in the past year (Figure 10). However, notably, there have been no transactions since March.
Figure 10 - ALHC insiders have yet to buy stock (dataroma.com)
Valuation Remains Challenging
With no signs of operating profits on the horizon, I fail to see why other authors are recommending investors accumulate shares.
Remember, the best that Alignment can do on MBR is 85% since the Centers for Medicare and Medicaid Services ("CMS") require health insurers to spend at least that amount on medical expenses for Medicare Advantage plans. This limits gross margin on Alignment's business at 15%. However, so far, Alignment has not been able to scale SG&A to sub-15% of revenues.
Furthermore, as I outlined in my prior article, the post-pandemic low in MBR of 85.1% in H1/22 is almost impossible to maintain. It basically involved seniors forgoing elective surgeries and other medical procedures because of COVID concerns. As we have seen in the quarters since, a more normalized MBR may be ~87-89% for Alignment. This means to earn any sort of economic return on capital, Alignment will have to actually reduce SG&A to sub-10% of revenues.
Until that happens, I believe it will be difficult for investors to properly value Alignment's business. However, for those that want to keep track, Alignment has been assigned a D- valuation grade by Seeking Alpha (Figure 11). Since Alignment is not profitable, traditional valuation metrics like P/E are not meaningful.
Alignment does look attractive on EV/Sales and Price/Sales multiples, as ALHC is trading at Fwd EV/Sales of 0.57x and Price/Sales of 0.69x compared to the Health Care median of 3.58x and 4.09x respectively. However, since ALHC spends $106 in expenses to drive $100 in revenues, sales-based valuation metrics may overly flatter the business.
Furthermore, comparing ALHC to established health insurers like UnitedHealth ( UNH ) and Elevance ( ELV ), we can see that ALHC does not screen particularly cheap on EV/Sales or Price/Cashflow metrics (Figure 12).
In short, investors are valuing Alignment like a disruptive technology company where operating losses are tolerated, even encouraged, as long as the company delivers growth. However, what they are failing to realize is that ALHC's target market segment, Medicare Advantage seniors, have capped profitability of 85% MBR. As long as SG&A as a % of sales remains meaningfully above 15%, it is mathematically impossible for ALHC to turn a profit.
Conclusion
After reviewing ALHC's quarterly earnings report and business development in the past year, I continue to recommend caution regarding Alignment's shares. Simply put, ALHC has not yet shown its business model of targeting Medicare Advantage seniors with their capped profitability is a worthwhile business. ALHC spends $106 in expenses to earn $100 in revenues. Until profitability improves, every dollar that ALHC generates in revenues will just lose the company money.
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Alignment Healthcare: Still Spending $106 To Earn $100 In Revenues