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Humana Inc.’s (HUM - Analyst Report) third-quarter 2012 operating earnings per share came in at $2.41, substantially beating the Zacks Consensus Estimate of $2.05. However, earnings per share (EPS) lagged the year-ago earnings of $2.54 per share.

The year-over-year earnings decline was attributable to lower pre-tax income in the company’s Retail and Employer Group segments, which were partially offset by higher year-over-year earnings in the Health and Well-Being Services segment.

The operating earnings exclude the positive impact of 21 cents and 13 cents per share in the third quarter of 2012 and the prior-year quarter, respectively, related to favorable development of prior-period medical claims reserves. On a reported basis, Humana earned $426 million or $2.62 per share in the reported quarter, against $445 million or $2.67 per share in the prior-year quarter.

Consolidated revenues for the reported quarter climbed 4.0% year over year to $9.65 billion, but lagged the Zacks Consensus Estimate of $9.86 billion. Revenues from premium increased 2.7% year over year to $9.09 billion, while services revenue surged 31.2% to $467 million in the reported quarter. Additionally, investment income grew 3.2% to $96 million in the third quarter of 2012.

Meanwhile, total medical membership increased 8.5% year over year to 12.02 million at the end of September 2012, while the total specialty membership at the end of the reported quarter hiked 11.9% to 8.03 million.

Humana reported benefit expenses of $7.47 billion, up 4.5% year over year, while operating costs climbed 3.5% year over year to $1.41 billion. Alongside, depreciation and amortization expenses expanded 11.9% year over year to $75 million.

Consolidated benefit ratio, which reflects the percentage of benefit expenses in premium revenues, increased by 150 basis points to 82.2% from 80.7% in the prior-year quarter, mainly due to a hike in the benefit ratio of the Retail and Employer Group segments.

The consolidated operating cost ratio, which reflects the percentage of operating costs in total revenues less investment income, inched down to 14.7% from 14.8% in the prior-year quarter, primarily as a result of improvement in operating leverage, which was partially offset by the adverse impact of the accounting changes for the company’s new South Region TRICARE contract.

Segment Results

Retail Segment: The retail segment includes Medicare Advantage and prescription drug plans, and individual health insurance business lines.

The segment’s pre-tax income plummeted to $424 million from $541 million in the prior-year quarter, on the heels of increased benefit ratio and favorable impact of prior-year medical claims reserve development.

Reported premiums and services revenue increased 14% to $6.14 billion in the reported quarter. The upside primarily resulted from an 18% year-over-year growth in individual Medicare Advantage membership.

The benefit ratio was 82.3% compared with 78.7% in the prior-year quarter. However, operating cost ratio decreased 50 basis points (bps) to 10.7% in the reported quarter.

Employer Group: The employer group includes employer group coverage and group Medicare Advantage and prescription drug plans.

The segment reported pre-tax income of $43 million in the reported quarter compared to $46 million in the prior-year quarter. Meanwhile, reported premiums and services revenue increased 14% to $2.64 billion, primarily on the back of higher group Medicare Advantage membership. The benefit ratio was 85.3% versus 83.5% in the prior-year quarter, whereas the reported operating cost ratio was 15.6%, up 190 bps from 17.5% in the year-ago quarter.

Health and Well-Being Services: Health and well-being services include pharmacy solutions, primary care services, home care services and integrated wellness services.

Pre-tax income for the segment increased substantially to $148 million from $83 million in the prior-year quarter, due to growth in the company’s pharmacy solutions business. Reported services revenue also increased to $3.20 billion from $2.83 billion in the year-ago quarter, primarily due to the growth in the Medicare Advantage enrollment and increased script volume in the company’s mail-order pharmacy business. However, operating cost ratio decreased 170 bps to 94.6% in the reported quarter.

Financial Update

Cash utilized in operations was $1.33 billion in the quarter under review, compared with cash flow of $2.92 billion in the year-ago quarter, mainly due to changes in working capital and reduced net income. Humana exited the quarter with cash and cash equivalents of $1.36 billion and long-term debt of $1.62 billion.

Share Repurchase Update

During the third quarter of 2012, Humana repurchased 3.52 million shares at an average price of $66.50 per share. As of November 5, 2012, the company had $640 million worth of shares outstanding under its share repurchase program, which will expire in June 30, 2014.

Business Update

Concurrently, Humana announced a definitive agreement to acquire a medical services organization – Metropolitan Health Networks Inc. – and purchased a non-controlling equity interest in another – MCCI Holdings LLC. Further, the company acquired Certify Data Systems, a company that facilitates exchange of health care data between healthcare providers and patients.

Outlook

Humana raised its 2012 earnings forecast to a range of $7.25–$7.35 per share from its earlier forecast of $6.90–$7.10 per share, mainly due to favorable development in the prior-year medical claims reserve and enhanced results in the stand-alone prescription drug plan business. The company also declared its EPS guidance of $7.60–$7.80 for 2013, including about 30 cents per share related to the increased investments in integrated care delivery models.

Consolidated revenue for 2012 and 2013 are expected to be in the range of $39.0–$39.5 billion and $40.8–$41.3 billion, respectively. Additionally, cash flow from operations is projected between $1.7–$1.9 billion in 2012 and $1.8–$2.0 billion in 2013. Moreover, capital expenditure is anticipated to be around $400 million in 2012 and between $425 million and $450 million in 2013.

Peer Take

UnitedHealth Group Inc. (UNH - Analyst Report), one of Humana’s peers, reported its third quarter 2012 earnings of $1.50 per share significantly ahead of the Zacks Consensus Estimate of $1.31 per share. Higher revenue across the board and strong enrollment growth, partially offset by higher operating costs, were responsible for the better-than-expected results. Also, share repurchases boosted the bottom-line earnings.

Another peer, CIGNA Corp.’s (CI - Analyst Report) third quarter core earnings of $1.71 per share significantly outpaced the Zacks Consensus Estimate of $1.37 per share.  Moreover, the results surged 33% year over year.

Zacks Rank

Currently, the shares of Humana carry a Zacks #4 Rank, implying a short-term Sell rating.

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