Molina Maintained at Neutral

We maintain our ‘Neutral’ recommendation on Molina Healthcare Inc. (MOH - Analyst Report) based on revenue growth, rising membership, strong operating cash flows and inorganic expansion. However, we remain cautious about the impact of rising medical costs and weak interest rates.

Molina reported second-quarter 2012 net loss per share of 80 cents, which was far behind the Zacks Consensus Estimate of earnings of 4 cents as well as the year-ago earnings of 38 cents. Net loss for the quarter came in at $37.3 million compared to net income of $17.4 million in the prior-year quarter.

Molina has been witnessing a steady increase in premium revenues over the past several quarters. Premium revenues surged 27.6% year over year to $2.82 billion in the first half of 2012. Also contributing to the increased revenues are more care intensive benefits and related higher premiums associated with the Aged, Blind or Disabled and Medicare members. Moreover, the efforts to trim down utilization and unit costs are expected to boost profitability by $6.6 million per month till the end of 2012.

The widening of the membership base is also a prime reason for the increase in revenue. Moreover, Molina has been expanding its geographic reach via acquisitions.

Further, Molina holds a healthy balance sheet with a steadily improving cash flow. The consistently rising cash flow trend is the result of increasing operating efficiency as well as higher premium income, along with the impact of deferred revenue. A long-term trend of rising cash from operations bodes well for the company, as it also paves the way for efficient capital deployment.

On the flip side, Molina lost a couple of important Medicaid contracts in the last few quarters, which are expected to substantially reduce its membership base, thereby negatively impacting revenues. Loss of the Missouri Medicaid contract in March 2012 is expected to reduce Molina’s membership by about 79,000 members.

Investment income, another prime component of Molina’s revenue, has been declining since 2007, primarily due to low interest rates. Additionally, rising medical costs are compressing margins. Moreover, higher-than-expected medical claims in Texas forced Molina to withdraw its 2012 earnings guidance in June 2012. Going ahead, any substantial elevation in operating expenses and medical costs could weigh heavily on margins and the bottom line.

Molina competes with Centene Corp. (CNC - Snapshot Report) and Wellcare Health Plans Inc. (WCG - Snapshot Report). The company currently carries a Zacks #3 Rank, implying a short-term ‘Hold’ rating.