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On Sep 24, 2013, we downgraded our recommendation on WellPoint Inc. (WLP - Analyst Report) to Neutral based on the cut in revenue guidance for 2013 at the second quarter conference call. Moreover, a persistent rise in expenses is expected to pull down margins in the upcoming period.

Why the Downgrade?

WellPoint reported its second quarter 2013 earnings on Jul 24, 2013. Its earnings for the second quarter came in at $2.60 per share, surpassing the year-over-year earnings of $2.04 by 27.5% and the Zacks Consensus Estimate of $2.08 by 25%.

However, WellPoint has been witnessing an increase in expenses for quite some time now. Moreover, the $1.7 million fine that is to be paid by WellPoint for inadequate security measures to protect policyholder information is expected to increase expenses further in 2013. Moreover higher medical costs in the Senior, Local Group and State-Sponsored businesses affected benefit expense ratio adversely.  Although it declined in the second quarter of 2013, it is expected to increase considerably by the end of 2013.

Moreover, the health care reform has reduced the selling season for the Medicare Advantage plans, which are privately administered versions of the federal health program for seniors. This is expected to bring down the sale of Medicare Advantage products. Further changes are to be implemented from 2014, such as the ban on annual and lifetime coverage caps, annual fees on health insurance companies and excise tax on high premium insurance policies which will likely increase expenses. Additionally, restriction on charging higher premiums from people with pre-existing medical conditions should increase the benefit expenses from 2014. All in all the new provisions are likely to pressurize profits going forward. Reduced revenue guidance (from $71–$73 billion to $70–$72 billion) further justifies our concern, while higher investment spending may hamper margins.

However amid all these negatives one aspect that strengthens WellPoint’s operations is its independent license for marketing products under Blue Cross Blue Shield Association (BCBSA), the most recognized brand in the industry. This managed care organization currently carries a Zacks Rank #3 (Hold). Moreover, its strategic acquisitions (CareMore, CareNex, Amerigroup) are expected to bolster membership growth in the upcoming period. Further, the agreement with International Business Machines Corp. (IBM - Analyst Report) to use its Watson technology should facilitate the delivery of faster and more efficient healthcare to WellPoint’s clients. Strong capital position and substantial earnings growth are some of the other factors that poise the company for long term growth.

Other Stocks to Consider

Other healthcare companies that are worth considering are Aetna Inc. (AET - Analyst Report) and UnitedHealth Group Incorporated (UNH - Analyst Report). Both these stocks also carry a Zacks Rank #2 (Buy).

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