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Following Aetna Inc.’s (AET - Analyst Report) first quarter earnings release, the rating agency Standard and Poor’s undertook a favorable rating action on the health insurer’s creditworthiness. The agency raised the financial strength ratings of the company’s subsidiaries by one notch to “A+” from “A,” while affirming the A-/A-2 counterparty credit rating on the parent company. All these ratings are of investment grade and carry a positive outlook.
The financial strength and credit ratings of a company are important metrics to determine its ability to fulfill policyholder obligations. These also affect investor confidence in the company’s potential and its competitiveness.
An investment-grade debt rating with a positive outlook reflects optimism about Aetna’s future performance. A positive outlook implies that the company’s rating may be raised over the following 12-month period.
S&P was particularly impressed with Aetna’s sound balance sheet, favorable operating results, strong cash flow generation, sufficient liquidity and financial flexibility. According to S&P, Aetna is on a stronger footing compared with its peers Humana Inc. (HUM - Analyst Report), CIGNA Corp. (CI - Analyst Report) and WellPoint Inc. (WLP - Analyst Report). It also noted that the gradually improving health insurance marketplace will further strengthen the company’s position.
The rating agency noted that despite significant Health Care Reform uncertainty, Aetna was able to secure its operating margins.
Aetna’s ratings may be raised another notch, if the company performs in line with the earnings expectations of the rating agency. The rating agency expects Aetna’s total revenue to be more than $36 billion, medical membership of 18.5 million (which is higher that Aetna’s guidance of 18.2 million members), pretax GAAP operating income in the range of $2.6–$3.0 billion and cash flow in the range of $3.4–$3.6 billion
S&P maintained the rating of the parent company two levels below the core operating units (generally the rating agency keeps a difference of three notches between the parent and the core operating units). The two-notch gap in the ratings reflect consistent dividends from Aetna’s diversified units, which minimize fluctuations in cash flow from the subsidiaries to the holding company.
S&P expects the company to get $1.7 – $2.0 billion in dividends from its subsidiaries, while Aetna expects subsidiary dividend of approximately $1.7 billion.
On the flip side, the rating agency pointed out that Aetna remains exposed to industry risks related to the Supreme Court hearing on the Health Care Reform and its negative impact on the health insurer, if any.
We are confident that the health insurer major will see a favorable rating outcome going forward, given the pace at which it is evolving. The company has made considerable investments in products and technology, with an intention to extend its core health business and also to capitalize on exciting new consumer and provider opportunities emerging in the marketplace.
Aetna's strong operating results and significant capital generation will allow it to make further investments. The company is expected to continue performing well in 2012 backed by the performance of the Medicaid and Medicare segments, a fast growing health services segment and a strong balance sheet.
Aetna currently retains a Zacks # 3 Rank, which translates into a short-term Hold rating. Considering its better-than-average fundamentals, we are maintaining our long-term Outperform recommendation on the shares.