Healthways Upgraded to Outperform

We upgrade our recommendation for Healthways ( HWAY - Analyst Report ) to Outperform. Second-quarter 2012 earnings per share of 15 cents beat the Zacks Consensus Estimate of 7 cents. We expect a sequential pickup in earnings as performance linked contracts are activated with the passage of 2012.

The Healthways model encourages people to make favorable lifestyle changes that lead to enhanced well-being, reduced healthcare costs, improved performance and economic value for customers. Brisk contract activity may enable the company to gradually get over the loss of the Cigna Corp. (CI) contract in the third quarter of 2011.

The company has invested in technology platforms that provide scalable support with large populations. Its Embrace technology setup won the company a top 10 position as a technology adopter. It is believed that Embrace will enable Healthways to integrate data from all the health care entities with which an individual interacts (to the extent that data is available electronically).

The company has tie-ups with 80% of U.S. health plans and counts about 39 million lives in its customer base. Growth in the U.S. is expected to slow down, and total billable lives may stagnate, which will be partly offset by cross-sell opportunities. Also, on the tepid side, Healthways considers itself to be a global well-being company but overseas contract wins have been restricted to just a few countries. Moreover, cash flow remains modest.

Healthways competes with Express Scripts ( ESRX - Analyst Report ) among others. The stock retains a Zacks #2 Rank, which translates into a short-term Buy rating.