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We retain our Neutral recommendation on WellPoint Inc. (WLP - Analyst Report), following the second quarter earnings. Earnings marginally lagged the Zacks Consensus Estimate but surpassed the year-ago results on the back of improved top line, which was driven by premium growth and higher Senior enrollment.
Counting on the positives, WellPoint has strengthened its portfolio through the acquisition of Medicare specialist, CareMore Health Group, in order to expand its presence in the U.S. government program for the elderly. Additionally, WellPoint collaborated with Health Care Service Corp. (HCSC) and Blue Cross Blue Shield of Michigan (BCBSM), to purchase a stake in Bloom Health, a private online health insurance exchange, in a bid to aggrandize its health insurance business.
The company is striving towards diversifying its products. It is also looking forward to adding new products and services to its State Sponsored business post the acquisition of Amerigroup. WellPoint expects this to strengthen its potential in the Medicaid and other related emerging markets.
WellPoint has been witnessing substantial earnings growth over the past few quarters, spurred by improvements in operating cost structure, strategic acquisitions and capital transactions.
WellPoint’s strong capital and cash position have also fueled cash dividends and stock repurchases. While the company began cash dividend payouts in early 2011, it has also engaged itself in aggressive share buybacks for more than a year now and is constantly utilizing its excess capital to retain investors’ confidence.
On the flip side, the company has been witnessing increasing debt to capital ratio. The ratio is also considerably higher than that of its closest peers, Unitedhealth Group, Inc. (UNH - Analyst Report) with a ratio of 27.52% and Aetna Inc. (AET - Analyst Report) with 31.5%. Although the company’s debt-to-capital ratio is still within the targeted range of 25% to 35%, as indicated by the bank covenants, it stands higher than the average of the health and managed care sector.
Although WellPoint has an extensive membership base consisting of almost 11% of the U.S. population, its membership has been declining since 2008. Management expects it to further decline due to the prevailing high unemployment levels and the impact of certain strategic changes.
Delayed product approvals for new health care reform compliant products are further affecting membership growth adversely. Additionally, the in-group membership change is expected to remain negative in 2012.
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 in 2011 adversely affected the benefit expense ratio. Benefit expense ratio in the first quarter was 83.5%, and further worsened in the second quarter to 85.4%. The ratio is expected to rise further by the end of 2012.
Increasing cost trends owing to the elevated use and cost of specialty pharmaceuticals have induced WellPoint to reduce its guidance for 2012.
Overall, we believe WellPoint has a substantial long-term growth potential given its leading market share positions, diversified product portfolio and strategic acquisitions.
WellPoint currently holds a Zacks #4 Rank (short term Sell rating) for the company, indicating slight downward pressure on the stock over the near term.