On Sep 23, 2014, we issued an updated research report on Humana Inc. (HUM). We believe that the company’s prudent capital management initiatives, focus on membership expansion and growth through the launch of Accountable Care Organizations (ACO) bode well. However, its weak financial position and increasing expenses raise concern.
Earlier, the company reported second-quarter earnings that were in line with the Zacks Consensus Estimate but lower than the prior-year quarter. The year-over-year decline was due to investments in healthcare exchanges and state-based contracts, along with an increase in specialty drug costs related to a new treatment of Hepatitis C.
Humana’s Medicare business accounts for a significant part of the company’s revenues. The Medicare collaborations have been increasing Humana’s memberships significantly. The addition of the Kentucky Medicaid Contract, Florida TANF contract and the Florida LTSS contracts increased state-based Medicaid membership. The company began offering its services in Illinois in the first quarter and Virginia in the second quarter of 2014 that boosted the Retail segment Individual Medicare Advantage membership. Through increased memberships, the company expects to provide HMOs in around 65 new counties by 2015.
Additionally, the Accountable Care agreements with Health4 in Mar 2014, UC San Diego Health System in Jun 2014, Tenet Healthcare Corp. (THC) in Jul 2014, Health Choice Preferred Network and Nebraska Health network in Aug 2014, Iora Health in Sep 2016 and partnership with CoverMyMeds in Feb 2014 are all in line with the company’s objective to provide affordable high-quality care to medical members.
Moreover, Humana’s strong capital management initiatives are expected to boost shareholders’ return. This month, the company authorized a $2 billion share repurchase program. Humana also scores strongly with credit rating agencies.
On the flip side, Humana has been incurring higher-than-expected expenses owing to increases in operating, depreciation and amortization costs. This trend is expected to continue in the upcoming period, given the higher-than-normal distribution costs and increase in commissions. Additionally, higher drug cost trends with respect to hepatitis-C drugs will likely lead to increase in overall expense for full-year 2014. Moreover, Humana operates in a highly competitive industry. The company is facing intense pricing pressure from peers, particularly from BlueCross BlueShield.
As per the Health Care Reform Law, Humana will have to pay health insurance industry fee. In this regard, the company expects to incur a payment of $560 million in 2014 and this fee is expected to increase by 41% in 2015. Additionally, based on the Centre for Medicare and Medicaid Services’ (CMS) provided medical cost trend assumptions that relate to the Medicare Advantage funding changes in 2015, Humana expects Medicare advantage funding to fall by 2%.
Moreover, Humana’s capital expenditures have been increasing over the past few years. It also rose in the first half of 2014. Additionally, the effect of the commercial risk adjustment, risk corridor and reinsurance provisions of the Health Care Reform are affecting the operating cash flow timings adversely. Thus, operating cash flow is expected to decline year over year for full-year 2014 as well.
Currently, Humana carries a Zacks Rank #3 (Hold). Better-ranked stocks in the healthcare services space that look attractive at current levels include Triple-S Management Corporation (GTS) and Centene Corp. (CNC). Both these have a Zacks Rank #1 (Strong Buy).
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