Aetna Reiterated at Neutral

We are reiterating our Neutral recommendation on the shares of Aetna Inc. (AET - Analyst Report) following the company’s second-quarter earnings release. The company‘s second quarter 2012 earnings came in at $1.31 per share, beating the Zacks Consensus Estimate by 6 cents, though it declined 3% year over year.

Better-than-expected earnings were attributed to higherrevenue, higher underwriting margins and increased membership in the company’s Medicare business.

We expect Aetna to continue reporting earnings improvement going forward. The company has made considerable investments in products and technology, with an intention to extend its core health business and capitalize on exciting new consumer and provider opportunities, which are emerging in the marketplace. Aetna's strong operating results and significant capital generation will enable it to make further investments.

This health insurance giant is expected to continue performing well in 2012 backed by the performance of its Medicaid and Medicare segments, fast growing health services segment, along with an expanding provider network and a strong balance sheet.

Aetna is aggressively expanding its reach in the Medicare business. The lifting of the Centers for Medicare & Medicaid Services (CMS) sanctions in June last year, and the acquisition of Genworth's Medicare Supplement business have boosted its Medicare platform. Aetna is focusing on developing solutions that help retirees to manage their health and employers to manage expenses. Both of these are growing challenges as baby boomers enter the Medicare program.

Aetna is also aiming at generating incremental fee revenues by managing infrastructure required for care organizations.

With respect to Aetna’s international business, the product launches in China, earlier during the year, met with initial success. The company also entered the Indian market with the acquisition of the Indian Health Organization. These are indicative of Aetna’s efforts to expand its global footprint and develop new business models.

Aetna has made a number of acquisitions in its Commercial business such as Prodigy. Prodigy's highly-customized offering addresses a portion of the self-funded market, covering approximately 27 million individuals. Additionally, the company also acquired PayFlex, an administrator of Flexible Spending Accounts (FSAs), Health Savings Accounts (HSAs) and other accounts that support consumer-based health plan designs.

Aetna’s balance sheet is quite strong with moderate leverage. Its excess cash generation in 2011 enabled it to complete four significant acquisitions, repurchase 45 million shares and institute a meaningful shareholder dividend.

However, membership growth, restriction on premium rate increase, an increase in medical costs expected in 2012 and a low interest rate environment are some of the headwinds, which the company is facing at this moment.

Aetna currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. Some of its peers within our coverage, who also retain a Zacks #3 Rank and a long-term Neutral recommendation, include CIGNA Corp. (CI - Analyst Report), WellPoint Inc. (WLP - Analyst Report) and Humana Inc. (HUM - Analyst Report).