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We have retained our Neutral recommendation on Molina Healthcare Inc. (MOH - Analyst Report) despite impressive second quarter results due to rising medical costs, declining investment income and the negative impact of the healthcare reforms. This multi-state managed care organization carries a Zacks Rank #3 (Hold).

Why the Reiteration?

Molina’s operating earnings for the second quarter of 2013 came in at $0.34 per share, surpassing the Zacks Consensus Estimate by 9.7%. Results also rebounded from the year-ago quarter’s loss of $0.71 per share.

Molina’s robust growth in premium and service revenues, investment income and rental income are the highlights of the strong second-quarter. Premiums have been increasing over the past few years and contributing to the increased revenues.

The first half of 2013 witnessed the same trend driven by membership growth in Wisconsin and Washington as well as higher rates in Texas and Washington in the second half of 2012. The second largest component of revenues viz. service revenues also surged in the first half keeping up with the drift over the past few years.

Membership of Molina is expected to be boosted by the Lovelace Community Health Plans contract for the New Mexico Medicaid Salud! Program as it will transfer Lovelace’s Medicaid members to the Centennial Care Program in New Mexico, of which Molina is a part.

Furthermore the acquisition initiatives of Molina aimed at expanding its geographic reach are impressive. Of particular importance are the acquisition of Health Information Management and Abri Health. The pending acquisition of certain assets of Community Health Solutions is also expected to bolster its growing membership. In addition, despite the cash outlays for inorganic growth, Molina holds a healthy balance sheet.

On the tepid side rising medical care costs and hence overall operating expenses has been posing a risk to the operating leverage of the company and weighing on margins. Also, upcoming changes like a ban on annual and lifetime coverage caps, annual fees on health insurance companies and excise tax on high premium insurance policies, will likely increase expenses further.

Moreover, the low interest rate environment has been dragging down investment income of the company and thus Molina needs to hedge its investment portfolio from market fluctuations to prevent further decline.

Other Stocks to Consider

Other healthcare companies that are worth considering are Aetna Inc. (AET - Analyst Report), UnitedHealth Group Inc. (UNH - Analyst Report) and WellPoint Inc. (WLP - Analyst Report). All these stocks carry a favorable Zacks Rank #2 (Buy).

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