Monday, November 27, 2006

Contrarian Stock Pick

So, I've been looking at a few companies recently. I still think that it's worthwhile to take a look at Texas Roadhouse (TXRH), and McCormick and Schmick's Seafood Restaurants (MSSR) maybe worth a look also. Wet Seal (WTSLA) kind of ran up a bit, and I do hope it pulls back some time, because I think the turnaround play still exists.

But, none of those companies I really want to talk about. Instead, I want to talk about Coventry Health Care (CVH). Unless you're on the East coast or in the Midwest, you probably haven't heard of them. Anyway, they are a national managed healthcare company based out in Maryland. They compete with big firms like Wellpoint (WLP), Aetna (AET), and United Health (UNH).

Compared to those three, Coventry is pretty small. At current prices, the company is trading at a 7.5B market cap. For comparison, Aetna has a 21.5B market capitalization, Wellpoint is worth 44B, and United Health is a behemoth with a 62B market cap. Despite being smaller than these bigger peers, it is run well. The company has been able to produce a strong return on its equity, and its operating margins are pretty good for the sector.

These are good things for a company, but there's something else going for CVH. As the industry consolidates, it will surely be considered as a takeover target. Now, I don't mean to say it's going to get bought out any time soon. But, in the next couple of years, it certainly wouldn't be out of the question. This story isn't all that different than the Oxford Health Plans story from a few years back. It was an unloved industry back then, and OHP was working on making a comeback. Then, United Health bought them out. Will history repeat itself? I really don't know, but I wouldn't bet heavily against it.

While most everything else is near a high, CVH is near its 52-week low right now. Currently, the S&P has it rated 5 stars, but Goldman Sachs and most other brokerages have a Neutral rating on the shares. I'd categorize this as a contrarian pick.

After running a few DCF scenarios ranging from bearish to bullish on CVH, I am getting a downside risk of roughly $5 and an upside potential of about $15 based on its current price of $46.79. Sounds good to me. Who wants to take a bite of this? I assure you it's not poisoned... it might be spoiled, but at least it won't kill you.


Jorge Monasterio said...

Why do you think it's gotten so low? What conditions will changed that?

Brute Force said...

The entire managed healthcare sector has been tanking. I believe the most recent declines are due to the fears of what the Democratic Congress can do to the industry.

It's overblown, imo. Sure, things they do could put on the hurt, but my belief is over time things will work themselves out. The companies will adapt to any changes, and earnings should remain strong. The sector on the whole is probably a good contrarian play, but I think based on valuation and management effectiveness, plus the takeover card, CVH is the horse for me.

In any case, I hope it comes back down a bit. It looks like my order to buy shares did not hit... missed it by a dime.