Sunday, November 21, 2010

The Long Term Case for Humana


As a result of the healthcare reform initiatives recently enacted, the health insurance industry is poised for fundamental change. We can be fairly certain about some things: Obamacare is the law of the land, Obamacare will not be repealed and, finally, Obamacare will be changed with the new Congress. Just what the changes will be and what the impact of those changes will be are anyone’s guess.

Humana Inc. (HUM) is a big player in this market. The Company is a benefits solutions company, offering an array of health and supplemental benefit products for employer groups, government benefit programs, and individuals. Humana operates in two segments: Government and Commercial. The Government segment consists of beneficiaries of government benefit programs, and includes three lines of business: Medicare, Military and Medicaid. The Commercial segment consists of members enrolled in its medical and specialty products marketed to employer groups and individuals. The Company provides health insurance benefits under health maintenance organization (HMO), private fee-for-service (PFFS) and preferred provider organization (PPO) plans.

Short-term, the greatest uncertainties are related to the Government segment of the business. The Company’s TRICARE contract with the government is expected to be extended for one year, through March 2012. There are no guarantees this contract will be extended this date. If it is not, Humana will book expenses related to the program’s termination.

The most significant uncertainty involves changes in the Medicare program. Humana is a big player in the Medicare Advantage program. Many health insurers are already closing Medicare Advantage programs and Humana is no exception. There will be consolidation within the industry and we expect Humana to benefit from this trend. Another trend is undeniable; the Baby Boom generation has begun applying for Medicare. This trend will continue for some years to come as the population continues to age.

Another strong point for HUM is its pharmacy benefits management business. This is an area that continues to demonstrate growth. We expect Medicaid reimbursement rates to experience downward pressure as states grapple with their own deficits. Medicaid is a huge cost for most states.

The Commercial segment is also in for significant change. Many smaller employers are dropping health insurance for their employees’ altogether. They find that paying the government a penalty for not providing insurance is less costly than providing insurance. This is an example of market forces at work.

The Company reported revenues of $8.42 billion for the quarter ended September 30, 2010 (3Q10). Humana’s revenue for the quarter ended September 30, 2009 (3Q09) was $7.72 billion. Earnings per common share (EPS) for 3Q10 is $2.32 and compared to $1.78 for 3Q09. Analyst projections for FY10 earnings range from $5.70 to $7.31 and average $6.91. The Company’s guidance is for EPS of $6.40 to $6.50, disappointing analysts.

Humana reports growth in revenues and operating profits across all segments of its business and reduced operating expenses. The balance sheet is reasonable. At September 30, 2010, the Company had cash, cash equivalents, and short-term investments of $11.54 billion, up 12 percent from $10.29 billion at June 30, 2010. The long-term debt to capital ratio is down to 19.4 percent in 3Q10 from 22.5 percent at FYE09.
The Company reports strong free cash flow. For the 3Q10, free cash flow per share was $6.77 as compared to $1.60 at 2Q10. Humana has a share repurchase plan in place. During 3Q10, the Company repurchased 968,000 of its outstanding shares. Approximately $150 million remains on the authorization.

There is a lot going for Humana as a mid or long term investment. The Company is well run, profitable and continues to grow. We think Humana offers a good opportunity for the patient investor.

Disclosure: Author has a long position in Humana.
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