Aetna Downgraded to Neutral


We are downgrading our recommendation on the shares of Aetna Inc. (AET) following the soft first quarter 2012 results. Reported quarter earnings missed the Zacks Consensus Estimate by 6 cents per share. Earnings also declined 6.3% year over year. Despite the increase in revenues, growth did not trickle down to the bottom-line results due to higher health care costs and operating expenses.

Though Aetna’s earnings fell short of the Zacks Consensus Estimate, we expect it to record top-line growth going further. The company has made considerable investments in products and technology, with an intention to extend its core health business and capitalize on new consumer and provider opportunities emerging in the marketplace.

Aetna's strong operating results and significant capital generation will enable it to make further investments. We expect the company to continue performing well in 2012 backed by the performance of the Medicaid and Medicare segments, fast growing health services segment and a strong balance sheet.

Aetna is also looking to generate incremental fee revenues by managing the infrastructure necessary for care organizations.

With respect to Aetna’s international business, the product launches in China, earlier during the year, have been sucessful. The company also entered the Indian market with the acquisition of the Indian Health Organization. These are indicative of Aetna’s efforts to expand its global footprint and develop new business models.

Aetna has made a number of acquisitions in its Commercial business such as Prodigy. Prodigy's highly-customized offering addresses a portion of the self-funded market, covering approximately 27 million lives. Additionally, the company also acquired PayFlex, an administrator of Flexible Spending Accounts (FSAs), Health Savings Accounts (HSAs) and other accounts that support consumer-based health plan designs.

Aetna’s balance sheet is quite strong with a moderate leverage. Its excess cash generation in 2011 enabled it to complete four significant acquisitions, repurchase 45 million shares and institute a meaningful shareholder dividend.

However, uncertainties surrounding the final outcome of the Health Care Reform, higher expected utilization in 2012 and a low interest rate environment are some of the headwinds faced by the company.

Aetna currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. Some of its peers within our coverage, who also retain a Zacks #3 Rank and a long-term Neutral recommendation, include CIGNA Corp. (CI) , WellPoint Inc. (WLP), Humana Inc. (HUM) and CVS Caremark Corp. (CVS).

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