We have reiterated our Neutral recommendation on Coventry Health Care Inc. (CVH) based on the company’s performance in the third quarter of 2011, which witnessed increased expenses coupled with tepid membership growth that marred the desired upside in the top line.
Coventry generated third-quarter 2011 operating earnings of 82 cents per share, which came in line with the Zacks Consensus Estimate but substantially lagged $1.29 per share reported in the year-ago quarter.
A continuous restructuring process in the Commercial Risk business, including both personnel changes and restoration of the appropriate level of collaboration drove up the membership of the segment, thereby increasing its revenue. In the first nine months of 2011, the business generated operating revenue of $4.5 billion, up 10.7% from the prior-year period.
Moreover, Coventry expects small group sales growth to continue to improve through 2011, given the efficient cost structure and positioning of its products that further benefits the bottom line. Higher-than-expected total earnings have also enabled the company to increase its 2011 earnings guidance thrice this year. Going ahead, management expects revenue to increase by $1.5–2.0 billion in 2012 over 2011.
Coventry also uses acquisitions for growth and targets small and local health plans in second-tier markets, where it can leverage its regional service centers and improve operating efficiencies, largely through economies of scale. Apart from acquisitions, the company also uses its free cash for share repurchases, thereby improving the bottom line. Moreover, in November 2011, Coventry increased its share repurchase authorization by 14.4 million shares.
Additionally, Coventry took advantage of the low interest rate environment to reduce its cost of capital as well as increase the term to maturity of the company’s debt in June 2011 by issuing the new 5.45% senior notes at the lowest rate for the company till date. Thus, while the interest expense has increased a little due to the new notes, the cost of capital and capital expenses of the company will likely reduce significantly in the next few years.
However, the quarterly operating cash flow of Coventry remains unstable, which may affect its normal operations. Additionally, the highly competitive industry environment impacts Coventry’s ability to increase premium rates in the fear of losing out prospective members to competitors.
Coventry has to compete with other managed care companies that have broader geographical coverage, more established reputations, greater market share, larger contracting scale, lower costs and greater financial and other resources. Such competition from bigger players will negatively impact Coventry’s membership.
Additionally, the provisions of the U.S. Health Care Reform Act are likely to impact health insurance premiums and Coventry’s ability to enroll beneficiaries and the viability of certain Medicare Advantage plans.
Further, the implementation of minimum medical loss ratio (MLR) regulations has greatly affected annual core earnings. The company expects MLR degradation of about 900 to 1,100 basis points in 2011, which translates into a negative year-over-year earnings impact at the midpoint of $0.15 per share.
The Zacks Consensus Estimate for Coventry’s fourth-quarter 2011 earnings is currently 65 cents per share, down 32% year over year. For full year 2011, the Zacks Consensus Estimate stands at $2.95 per share, down 20% from 2010.
Coventry competes with WellPoint Inc. (WLP) and Unitedhealth Group Inc. (UNH).Currently, the company carries a Zacks #3 Rank, which translates into a short-term Hold rating, indicating no clear directional pressure on the shares over the near term.
COVENTRY HLTHCR (CVH): Free Stock Analysis Report
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