Coventry Health Care Moat Check

Continuing on review of potential wide moat companies, today I’m going to take a look at Coventry Health Care Inc. (CVH). Coventry Health Care is a Bethesda, Maryland based managed healthcare company that has been in operation since 1986. The company’s services include:

• Health maintenance organization (“HMO”)
• Preferred provider organizations (“PPO”)
• Point of service products (“POS”)
• Medicare advantage
• Medicare prescription drug plans
• Medicaid
• Workers’ compensation
• Network rental to other insurance carriers and administrators
• Management services

Justin over at the Rule One Investment Community ran Coventry Health Care Inc. through his spreadsheet. The results look pretty good. The company’s ROIC has been above 10 percent since 1999. Earnings, sales, book value and free cash flows have also been increasing at double digit rates over the past nine years, five years, and also this past year. Justin’s spreadsheet does not include Coventry Health Care’s latest financials just released this past week. The latest quarterly results continue the company’s outstanding financial performance trend.

However, just because a company has good financials does not mean that it has a wide moat. The managed healthcare sector is intensely competitive. I’m currently reviewing a list of over a dozen health plans for my family’s care next year. Price and services are the main attributes I’m reviewing when selecting a plan. The branding of health plans only makes up a small portion of the decision. Coventry Health Care does not really have any strong nationally recognized brands or product names.

The only potential avenue for Coventry Health Care to have a wide moat is by being a low cost producer. Coventry Health Care appears to have operated fairly cost-effectively. However, it is not clear that they are the lowest cost producer of health care plans. Even if they were the lowest cost producer, government intervention in this sector could still potentially impact future profits.

Much of Coventry Health Care’s growth has come from acquisitions.  This is a big red flag in my book. This acquisitions have included:

Those are a lot of acquisitions!  The accounting gets rather messy with so many new entities getting added. There is the potential for managing earnings with all the flexibility afforded with merger accounting rules. On the flip side, if Coventry Health Care was able to acquire these companies at discount prices, these acquisitions may have really boosted the long-term value of Coventry Health Care.

My biggest concern with investing in any insurance company is whether they properly price their products for the costs of the risks involved.  It is really best to analyze insurance company during tough markets, because that is when you can find out whether they are disciplined in their pricing.  The health insurance sector has been doing really well for the past few years, so it is tough to determine Coventry Health Care’s pricing discipline.  Also, CEO Dale Wolf has only been in his position since January 2005.

There are a lot of questions regarding Coventry Health Care’s moat in my mind.  They might have a small moat but it is too hard for me to tell.  I’d love to hear your opinions on this stock.  For now, I’m going to put this one on my pass pile, but I could change my mind as I learn more about this company.