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On Nov 22, 2013 we downgraded managed care organization, WellPoint Inc. (WLP - Analyst Report), to Neutral, based on concerns like the company’s high financial leverage and increased competition. WellPoint carries a Zacks Rank #3 (Hold).

Why the Downgrade?

While WellPoint’s third quarter 2013 operating earnings of $2.10 surpassed the Zacks Consensus Estimate by 14.8%, it was only a penny higher when compared to the year-ago earnings. On the other hand revenues, which were higher than the year-ago numbers, were in line with the Zacks Consensus Estimate.

WellPoint’s high financial leverage is a matter of concern at present. The debt-to-capital ratio is higher than the average for the health and managed care sector. In fact, the ratio has also exceeded the targeted range of 25%–35%, as indicated by the bank covenants.

Moreover, higher medical costs in the Senior, Local Group and State-Sponsored businesses, lower favorable prior year reserve development and the impact of minimum medical loss ratio requirements affected the benefit expense ratio adversely. For the full year 2013, it is expected to increase to about 84.5% to 85.5%.

Again, the health care reform that has reduced the selling season for the Medicare Advantage plans is expected to bring down the sale of Medicare Advantage products. Further changes that will 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 will likely increase expenses. Additionally, restrictions on charging higher premiums from people with pre-existing medical conditions and the establishment of the minimum medical loss ratios should increase expenses, pressurizing profits going forward. Also, competitive threats from equally strong peers might limit WellPoint’s business opportunities and have an adverse impact on the company’s financials going forward.

However, amid all these negatives, WellPoint’s operations are strengthened by its independent license for marketing products under the Blue Cross Blue Shield Association (BCBSA), the most recognized brand in the industry and strong capital position. Moreover, the acquisition of Amerigroup that enhanced memberships during the quarter, and a contract to administer hospital and medical health benefits of 32BJ, New York’s leading union of property service workers, that is scheduled to commence on Dec 1, 2013 should bolster WellPoint’s top line, going forward.

Other Stocks to Consider

Some better-ranked healthcare service providers include VCA Antech Inc. (WOOF - Snapshot Report), Addus HomeCare Corporation (ADUS - Snapshot Report) and Acadia Healthcare Company Inc. (ACHC - Snapshot Report). While Addus carries a Zacks Rank #1 (Strong Buy), VCA Antech and Acadia Healthcare carry a Zacks Rank #2 (Buy).

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