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On Jan 30, 2013, we downgraded Molina Healthcare Inc. (MOH - Analyst Report) to Neutral from Outperform based on its rising medical costs and the negative impact of the healthcare reforms.

Why the Downgrade?

Molina is witnessing rising medical care costs, which are compressing margins. Further, the establishment of the medical loss ratio mandate of the healthcare reform is increasing the costs of healthcare companies.

Further changes, which will be implemented from 2014, such as the ban on annual and lifetime coverage caps, annual fees on health insurance companies and excise tax on high premium insurance policies, will likely increase the expenses of healthcare companies such as Coventry Health Care Inc. and Health Net, Inc. (HNT - Analyst Report).

Molina also lost a couple of important Medicaid contracts in 2012, which are expected to reduce membership base, thereby negatively impacting revenues. The loss of the Missouri Medicaid contract reduced this managed care company’s membership by about 79,000 members. Investment income, another prime component of Molina’s revenue, has been declining since 2007, primarily due to lower interest rates.

Moreover, the Zacks Consensus Estimate for Molina’s fourth-quarter 2012 earnings declined 4.6% to 21 cents during the last 30 days based on 2 downward estimate revisions. Additionally, over the last 30 days, the Zacks Consensus Estimate for 2012 of a loss of 12 cents widened 8.3% to 13 cents. Both the quarterly and annual results will likely decline 60% and 108% year-over-year, respectively.

These downward estimate revisions also had an impact on Molina’s Zacks Rank, which was downgraded to Zacks Rank #3 (Hold) from Zacks Rank #2 (Buy).

Molina is scheduled to report its fourth quarter and full year 2012 results on Feb 7.

Other Stocks to Consider

While we remain cautious on Molina, another health maintenance organization American Caresource Holdings, Inc. , carrying a Zacks Rank #2 (Buy), is worth considering.

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