Health Equity – Rich Valuation Concerns?


The market wide sell-off in equities during the fourth quarter has disproportionally impacted growth stocks that possess high price-to-earnings multiples translating into rich valuations. The market appears to have lost its appetite for the high growth and steep valuation equities that had huge upward moves throughout this record setting bull market. Health Equity (HQY) continues to post quarter after quarter double-digit growth in revenue and EPS and has been rewarded with a rich valuation as a function of its impressive growth. This high price-to-earnings multiple may be in jeopardy as the market moves into a risk adverse environment. As high-flying equities come down in the broader market sell-off, Health Equity may come down as a result and erase some of its monster gains that were witnessed in 2018. To be clear, Health Equity is an intermediary servicing the secular growth Health Savings Account (HSA) space that’s largely independent of legislative actions, drug pricing, rising insurance costs and not playing any role in the pharmaceutical supply chain. HealthEquity manages funds allocated for medical, dental and vison expenses that are deducted on a pre-tax basis and deposited into a dedicated HSA account. The company blew out the numbers when it reported its Q3 FY19 results and beat on both the top and bottom line.

HealthEquity manages $7.1 billion in assets across 3.7 million accounts against a potential market maturity of $1 trillion in assets across 50-60 million accounts. The durability of this growth has a long runway due to the secular growth in the HSA market. The company is sitting on largely untapped revenue sources where the vast majority of account holders have yet to invest any HSA money in investment offerings. Expanding margins for greater profitability is also unfolding as the older the account, the greater the gross margins. HealthEquity is currently sitting on a healthy balance sheet with $330 million in cash and cash equivalents with no debt. The company is posting accelerating revenue, cash flow, margin expansion and income growth with a strong balance sheet. I feel that HealthEquity will continue to post strong growth as it services the double-digit HSA growth market and manages more assets, accounts and investments within these accounts. HealthEquity may be a great long term investment in the healthcare space that’s independent from the health insurances, pharmaceutical supply chain companies, drug makers or pharmacies. Previously, I warned that the “current valuation is rich in an already frothy market thus caution at these levels is wise” and now it appears this heeding was responsible as the stock has sold off from $101 to $74 shedding 26% of its market value during the fourth quarter. Health Equity looks compelling after this healthy correction as the long term narrative remains intact.

HealthEquity’s FY19 Q3 Earnings:

Q3 FY19 earnings delivered another double digit growth story across the board with revenue coming in at $70.5 million, an increase of 24% year-over-year. Net income came in at $15.7 million, an increase of 50% year-over-year. Total HSA members came in at 3.7 million, an increase of 22% compared to Q3 FY18. Total custodial assets were $7.1 billion, an increase of 27% compared to year-over-year (Figure 1).

“HealthEquity delivered robust third quarter results, strengthening our momentum going into the important fourth quarter and year end,” said Jon Kessler, President and CEO of HealthEquity. “By adding more than $1.5 billion in additional custodial assets since the end of our third quarter last year, our growth continues well ahead of the market, allowing us to raise guidance for fiscal year 2019. Importantly, with custodial investment assets growing by 53% over the third quarter end last year, we are delivering on our promise to help our HSA members connect health and wealth and put them on the fast track to retirement readiness.”

The company is in a very healthy financial position and had $330.3 million of cash, cash equivalents and marketable securities and no outstanding debt. Total custodial assets were $7.1 billion, an increase of 27% year-over-year which is broken out into custodial cash assets of $5.6 billion, an increase of 22% and custodial investment assets of $1.5 billion, an increase of 53%. The latter will serve as a major growth driver as an untapped revenue source. We’re witnessing early adoption of this revenue source now that $1.5 billion is allocated in investment assets. Collectively, these great financial metrics have translated into fantastic stock performance over the past year with the stock nearly tripling until the recent market wide sell-off (Figure 2).

Figure 1 – Infographic depicting Health Equity’s big picture metrics

Figure 2 – HealthEquity’s growth across major business metrics

Future Growth and Healthcare Cost Containment Play:

HealthEquity is one of the major players in the HSA secular growth market and has continued to gain market share over the years. Currently, HealthEquity manages $7.1 billion in assets across 3.7 million accounts against a potential market maturity of $1 trillion in assets across 50-60 million accounts. The company currently has 15% market share in number of accounts and custodial assets. HealthEquity has been growing market share with plenty of market expansion ahead of itself. Assuming a 15% penetration in both number of accounts and assets, HealthEquity’s maturity may come in at 8.25 million accounts and $150 billion in custodial assets, respectively (Figure 1).

HSAs are becoming an invaluable option for consumers to contain medical costs and take control of healthcare spending. High Deductible Health Plans (HDHP) coupled with HSAs contained family plan deductibles at a far lower level than any other healthcare plan. HDHPs have a 10-year CARG deductible of only 2.8% while the HMO model comes in at 8.2% over the same period. Additionally, funds deposited in the companion HSA account can be invested into mutual fund options to grow these funds over time. At age 65 these funds can be withdrawn without penalty at your effective rate, effectively serving as a second 401k over time. This dual purpose account serves as a great means to contain healthcare costs while building wealth via investments over the long term.

Figure 3 – Market potential for the HSA market

Untapped Revenue Sources and Margin Expansion:

HealthEquity is posting accelerating revenue, cash flow and income growth. The company is sitting on untapped revenue sources and plenty of room for margin expansion. In terms of untapped revenue sources, of the 3.7 million members, 96% of account holders have yet to invest any money within its HSA accounts. This serves as an untapped pool of money that can invested in various mutual funds while HealthEquity collects a small fraction of the dollar amounts invested in these investment accounts as management fees. Considering that the average age of an account is only 3.5 years and over 41% have been open for 2 years or less, this provides ample opportunity for future penetration in this investment space. Given the fact that these account balances are correlated with age translates into more probability that any surplus will be invested to further drive account value. As the company continues to grow, the float of HSA funds is expanding at a rapid clip year-over-year in a rising interest rate environment which only contributes to bottom line revenue to underpin the business.


HealthEquity has continued its path of accelerating revenue, cash flow and income growth across all segments of its business in the backdrop of an HSA secular growth market. Despite these great financial metrics, throughout the fourth quarter the market has become risk adverse and many high growth names have been met with correction territory. Health Equity is no exception and has seen over 25% of its market capitalization erased. HealthEquity looks compelling after this healthy correction as the long term narrative remains intact. The company is debt-free and expanding its balance sheet with just over $330 million in cash and cash equivalents. HealthEquity currently manages $7.1 billion in assets across 3.8 million accounts against a potential market maturity of $1 trillion in assets across 50-60 million accounts. The company is sitting on untapped revenue sources and gross margin expansion beginning to bear fruit as accounts age and more funds are channeled into investment vehicles. HealthEquity is continuing to post strong grow as it expands the number of accounts, manages more custodial assets, expands gross margins and more accounts transitioning into investment vehicles. Furthermore, HSAs are serving as a dual purpose as a healthcare containment play while serving as a second 401k as assets can be withdrawn in retirement without plenty fueling the popularity of these accounts.

Disclosure: The author does not longer hold shares of HealthEquity. The author has no business relationship with any companies mentioned in this article. He is not a professional financial advisor or tax professional. This article reflects his own opinions. This article is not intended to be a recommendation to buy or sell any stock or ETF mentioned. Kiedrowski is an individual investor who analyzes investment strategies and disseminates analyses. Kiedrowski encourages all investors to conduct their own research and due diligence prior to investing. Please feel free to comment and provide feedback, the author values all responses. The author is the founder of a venue created to share investing ideas and strategies with an emphasis on options trading.

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