Elevance Health's Shift Towards Value-Based Care and Strategic Reset
The U.S. healthcare system is increasingly shifting towards an integrated, value-based care model, diverging from the traditional fragmented fee-for-service structure. Companies capable of managing both the financial aspects and delivery of healthcare are positioned to benefit from this transition. Elevance Health is strategically aligned with this shift, although market perceptions have remained focused on short-term challenges, notably the company's guidance for 2026 expected as a low earnings point. This focus has led to some restraint in stock performance. However, the core investment appeal lies in the potential gains once Carelon, Elevance's service arm, achieves efficiency levels comparable to its industry peers.
For a precise valuation of Elevance, it is crucial to consider a normalized earnings baseline. In fiscal year 2025, the adjusted diluted earnings per share (EPS) stood at $30.29, which included approximately $3.75 from one-time positive items primarily related to tax benefits. Adjusting for these components, a normalized EPS for 2025 is closer to $26.54. Against this backdrop, the guidance of at least $25.50 in EPS for 2026 suggests a strategic reset rather than a fundamental decline. This represents an effort to clean up and enhance the earnings base by divesting from lower-margin businesses.
Two main factors contribute to this strategic reset. First, Medicaid margins are anticipated to weaken as state reimbursement rates lag behind increased care needs post-redetermination of Medicaid eligibility. Concurrently, Elevance is exiting certain Medicare Advantage markets that are not profitable, impacting membership levels but ultimately refining the quality of its coverage portfolio. This approach aims to establish a stable financial platform amid regulatory changes and evolving healthcare utilization patterns.
The upside potential is largely centered around Carelon, Elevance's services platform designed to emulate the vertically integrated models seen in firms like UnitedHealth and Cigna, known for achieving superior margins. In 2025, Carelon generated $71.7 billion in revenue, an increase of 33% year-over-year, yet its adjusted operating margin was 4.8%, a decline from the prior year. The opportunity lies in improving these margins. A shift from 4.8% to a conservative 6.5% could significantly enhance incremental operating income and EPS.
Within Carelon, there is a clear pathway toward improved margins. CarelonRx is nearing industry margin standards, while Carelon Services still has potential for enhancement. The focus is on refining existing operations to improve pricing, service mix, risk-based offerings, and operational efficiencies.
Elevance has reiterated its long-term goal of achieving approximately 12% annual EPS growth. While ambitious given the anticipated 2026 earnings trough, the target becomes more achievable with planned margin improvements. Beyond Carelon, Elevance seeks broader margin recovery across its operations. Even a modest margin increase on a projected $200 billion revenue base can translate into substantial operating income growth and corresponding EPS improvements.
Elevance presents a potentially attractive investment proposition at roughly 13 times its forward earnings, offering an earnings yield of about 7.7%. The anticipated return consists of current earnings yield, prospects of mid-teens EPS growth dependent on achieving margin goals, and potential for a market valuation uplift if confidence grows in its earnings stability.