We are downgrading our recommendation on Health Net Inc. (HNT) to ‘Underperform’ from ‘Neutral’ on the back of disappointing first-quarter earnings. Financial leverage also deteriorated with higher debt-to-total capital ratio and lower shareholders’ equity.
Health Net’s first-quarter 2012 operating income, which includes combined net earnings from Western Region and Government Contracts segments, came in at 10 cents per share, declining substantially from the year-ago level of 78 cents per share. Operating income was also significantly lower than the Zacks Consensus Estimate of 60 cents per share.
Health Net’s total revenue has been declining over the past few quarters, mainly due to lower revenues from the Government Contracts segment arising from the new T-3 TRICARE North contract, which restricted the earnings that can be recognized.The rate of customer attrition in the company’s health plans also remains a cause for concern.
While total health plan enrollment remained almost flat in 2011, it declined 2.6% and 19% year over year in 2010 and 2009, respectively. Further, membership is expected to remain almost flat in 2012, thereby limiting revenue growth.
Moreover, Health Net had to incur a significant amount of litigation related expenses in the recent past, which not only increased the debt but also weighed heavily on the financial leverage. Last year, the company borrowed $185 million under its revolving credit facility mainly to pay litigation expenses.
However, Health Net has a strong capital and liquidity position with total cash and investments of $1.8 billion against total long-term debt obligations of $746 million at the end of March 2012. Additionally, the investment portfolio of the company is strong, with an average rating of “A+” and “A1” as per S&P and Moody’s, respectively.Strong 2012 earnings guidance also provides optimism for the upcoming quarters.
Health Net has also been slowly disposing its non-profitable businesses. The divestiture ofthe Medicare stand-alone Prescription Drug Plan (PDP) business ofthe company’s subsidiary – Health Net Life Insurance Co. – is expected to be beneficial for Health Net given the steady decline in its PDP enrollment, along with a constant hike in the PDP Medical Care Ratio.
Currently, the Zacks Consensus Estimate for Health Net’s second-quarter 2012 earnings stands at 67 cents per share, down 11.6% year over year. Of the 12 estimates, 2 moved downward in the last 30 days, while no upward revision was witnessed.
For 2012, the Zacks Consensus Estimate is pegged at $2.27 per share, down 26.3% year over year. The company competes with WellPoint Inc. (WLP) and UnitedHealth Group Inc. (UNH).
Currently, Health Net carries a Zacks #5 Rank (short-term ‘Strong Sell’ rating).
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