We are downgrading our recommendation on Humana Inc. (HUM) to Underperform, owing to the company’s added focus on Medicare Advantage plans that increases its revenue dependency on one segment, rising expenditure, overhang of litigation charges and increasing competition in the industry.
We believe the company needs to be prudent regarding its expenditures and focus on its growth strategy through acquisitions and diversify its sources of earning premiums to attract long-term investors. Its second quarter earnings per share of $2.34 beat the Zacks Consensus Estimate of $2.23. However, it lagged the year-ago earnings of $2.59.
The year-over-year earnings decline was attributable to lower pre-tax income in the Retail segment, which offset the earnings growth in the Employer Group and Health and Well-being Services segments. Improved medical and specialty memberships led to revenue growth, which was offset by higher expenses and high benefit ratio utilization, thus leading to reduced earnings guidance for 2012. However, share buyback and dividend payment provided some respite. Meanwhile, acquisitions are expected to enhance the company’s Medicare coverage.
The rating downgrade is attributable to the company’s inefficiency in controlling its surging expenditures owing to increases in operating cost along with depreciation and amortization costs. Total operating expenses have continuously augmented since 2009. It rose 4.9% year over year in 2009, 9.3% in 2010, 8.7% in 2011. Moreover, it climbed 6.8% year over year to $9.11 billion in the second quarter of 2012.
Mounting number of lawsuits continues to adversely affect Humana and simultaneously weigh on investors’ sentiment and hinder the company’s goodwill at large. Moreover, Humana operates in a highly competitive industry. Competitors always look to grab market share by offering services at reduced prices.
However, on the brighter side, the company has been aggressively strengthening its business platform over the last several years. It has developed various products to meet the needs of employees who are distressed by inflation in medical costs.
Humana also scores well with the rating agencies. Standard & Poor's ("S&P") reiterated its long-term counterparty credit rating (:CCR) on Humana at ‘BBB’. The outlook was also revised to positive from stable. Earlier, in February 2012, Fitch affirmed the company’s Issuer Default Rating (:IDR) at “BBB” and the rating of its senior unsecured notes at “BBB-”, along with a positive outlook for all the ratings.
Humana currently retains a Zacks #4 Rank, which translates into a short-term Sell rating. Its peers, Unitedhealth Group, Inc. (UNH) and Cigna Corp. (CI) carries a short-term Zacks #2 Rank (Buy) while Aetna Inc. (AET) holds a short-term Zacks #3 Rank (Hold).Read the Full Research Report on AET
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