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Molina Raised to Outperform

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We have upgraded our recommendation on Molina Healthcare Inc. (MOH - Free Report) to Outperform from Neutral, owing to the uptrend in premium and service revenue along with improving membership. Additionally, the company’s strategy of expansion via acquisitions is benefiting its Medicaid business.

Molina has been witnessing a steady increase in premium revenues, which account for a majority of the revenues, over the past several years. It increased 87% over the past four years (2007-2011). Further, premium revenues surged 29% year over year in the first nine months of 2012.

Service revenue, the second largest component of Molina’s revenue, has also been increasing gradually since 2010. The first nine months of 2012 witnessed a year-over-year surge of 19%. As a result of the increasing premium and service revenue, the company’s total revenue has also been improving steadily since 2007.

Moreover, Molina’s membership has been increasing due to the creation of new health plans and the development of the existing ones. Aggregate membership increased 9% over the first nine months of 2012 and currently, the company serves nearly 1.83 million members.

Molina holds a healthy balance sheet with a steadily improving cash flow. It increased 130% in the first nine months of 2012 due to higher medical claims and benefits from the Texas health plan and higher deferred revenue.

However, management remains cautious about the rising medical care costs, which are compressing margins. Medical care costs have spiked dramatically by 84% in the four year period (2007-2011). The first nine months of 2012 also witnessed the trend.

Moreover, the higher-than-expected medical claims and an MCR of 120% for the STAR+PLUS plan in two new Texas markets forced Molina to withdraw its 2012 earnings guidance in June 2012. The high operating expenses pose a risk to the company’s operating leverage.

Molina currently carries a Zacks #3 Rank, implying a short-term ‘Hold’ rating. Peer Health Net Inc. carries a Zacks #2 Rank (Buy).

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