We have upgraded our recommendation on Molina Healthcare Inc. ( MOH - Analyst Report ) to Outperform from Neutral based on its steadily increasing premium revenue, membership growth and a strong 2012 financial guidance. Moreover, the improvement of the Medicaid health plan business due to the strategy of expansion via acquisitions could be a significant opportunity for the company.

Molina reported third quarter operating earnings of 41 cents per share, which came in 2 cents ahead of the Zacks Consensus Estimate. Results were also 8% higher than 38 cents in the year-ago quarter.

The steady increase of premium over the past several quarters is driving revenue growth. The widening membership base is also contributing to the increased revenues. The company has the eighth-highest enrollment in the Medicare special needs plan for dual-eligible members in the US.

Moving ahead, we believe premium revenue will continue to be a significant revenue driver for Molina. This is also evident from management’s guidance of $5.9 billion in premium revenues in 2012. Moreover, the increased premium rates in Florida and Michigan will positively impact revenue in 2012.

Additionally, Molina has been expanding its geographic reach via acquisitions. While the acquisition of the Health Information Management business of Unisys Corporation ( UIS - Analyst Report ) adds value to the company’s Medicaid health plan business, the acquisition of Abri Health Plan has brought in a vast exposure covering 23 counties in Wisconsin and approximately 28,000 Medicaid members.

However, Molina’s rising medical costs are compressing margins, remain causes for concern. Higher operating expenses pose a risk to the company’s operating leverage.

Moreover, Molina’s investment income has been declining since 2007. As a percentage of revenue, it declined from 1.2% in 2007 to 0.15% in 2010. Given the persistent low interest rate trend, the percentage of investment income in the revenue will likely keep declining further going ahead.

The Zacks Consensus Estimate for fourth-quarter 2011 currently stands at 39 cents per share, up 1.7% year over year. For 2011, the Zacks Consensus Estimate is $1.55 per share, up about 18% over 2010.

Molina carries a Zacks #2 Rank, which translates into a short-term ‘Buy’ rating.