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The Call @ Hedgeye | March 28, 2024

Takeaway: Please join us on Wednesday June 12 @2PM ET when we will be reviewing our short thesis on HQY

ROUND TRIPPING YIELDS IN QUADS 3 & 4: HQY BEST IDEAS SHORT

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Wednesday, June 12 @ 2PM ET

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Healthcare Subscribers: CLICK HERE for event details (includes video link, materials link and dial-in) http://app.hedgeye.com/feed_items/75731 

Health Policy Subscribers: CLICK HERE for event details (includes video link, materials link and dial-in).http:feed_items/75732//app.hedgeye.com/

Background

Health Equity's (HQY) core market has experienced rising penetration of high deductible health plans (HDHP) by employer plan sponsors, and to HQY's benefit, often accompanied by health savings accounts (HSA). For some time we have believed peak penetration is approaching and growth for the industry is slowing.  While slowing member growth has indeed occurred as we expected, HQY enjoyed several additional benefits that continued to push growth, guidance, and consensus higher through 2018, carrying the shares to a peak of $100, the EV/EBITDA multiple to a peak of 44X, and the P/E to a peak of 80X. As of June 2019 and a $64 share price, the shares still carry EV/EBITDA and P/E multiples of 25X and 45X, respectively.  With headwinds gathering momentum, we believe it is time to press the short.

Thesis

HQY makes money on their members through service fees paid by the employer plan sponsor; custodial yield on cash balances held for members to purchase medical care; fees on tax advantaged investment balances; and fees on medical care transactions, or interchange revenue. Growth is at risk across all of these key drivers.  

  • Member growth is at risk of incremental deceleration as employment slows given the macro economic set up, and possibly declines in a recession scenario. 
  • Penetration of HDHP-HSA accounts has remained at 19% according to Kaiser in the last three annual surveys.  We believe the policy tailwinds have largely subsided. The benefits of having 'skin in the game' that has been touted since the late 1990s, have largely played out while employers offset historic lows in unemployment with more generous benefits.
  • Republican-driven policy to expand HSAs to working Medicare populations; raise the contribution limits, or otherwise make the program more attractive are dead in the Potomac River as Capitol Hill remains divided for the foreseeable future.
  • Yields on custodial assets benefited from rising prevailing interest rates. While there will be a delay between falling rates and Custodial Yield, the path to lower rates appears all but assured.  We believe investors will recognize the future impact despite the custodial asset investment structure with substantial earnings headwinds from falling yields.
  • Investment account balances and fees are likely to continue to be significantly impacted by slowing economic growth and its impact on market prices.
  • Interchange revenue is likely to be volatile as consumers balance saving and spending in the face of rising job insecurity and benefits stability. 
  • WAGE acquisition looks interesting for a very long term investor as HQY expands it's consumer directed health offerings, although we have questions on how compelling FSA, COBRA, and Commuter offerings actually are.  While the WAGE turnaround appears ongoing, consensus estimates reflect management's positive outlook even though the acquisition will dilute HQY's growth rate and custodial yield narrative.  We believe slower growth and lower margins for the combined entity brings with it a lower multiple or worse if the core HQY model has growth issues. 

Macro Quad, Risk Score

The US economy is balanced between two negative growth environments, Quad 3 and Quad 4 in Hedgeye terms, and the Federal Reserve that has already turned dovish and market yields have already fallen. With HSA member growth likely to continue to decelerate, and potentially decline in a recessionary scenario, we are watching HQY 's deteriorating Risk Score as complimentary to our fundamental outlook. With fundamental pressures mounting, a negative economic backdrop, and a deteriorating Risk Score, high valuation, we remain short HQY.

CALL INVITE WEDNESDAY JUNE 12 @ 2PM: HQY | ROUND TRIPPING YIELDS IN QUAD 3 & 4: BEST IDEAS SHORT  - hqysentiment

Thomas Tobin
Managing Director


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Emily Evans
Managing Director – Health Policy



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