Aetna Continues to Impress

Big health insurers have been posting strong profit gains and showing solid top-line growth.
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Major health insurers continue to take good care of their investors.

Take

Aetna

(AET)

, whose shares have nearly tripled over the past couple of years. On Thursday, the company reported second-quarter revenue of $5.5 billion -- up 13% from a year ago -- that just topped the consensus estimate. Meanwhile, net income jumped a whopping 43% to $410 million as the company continued to expand its customer base, deliver strong underwriting results and achieve operating efficiencies. Excluding a favorable reserve development, the company posted quarterly profits of $1.08 a share that matched Wall Street expectations.

Goldman Sachs analyst Matthew Borsch says Aetna's second-quarter earnings, which beat his own forecast by a penny, should soothe investors for now.

"We expect AET stock will rebound somewhat today on solid, in-line 2Q results that should relieve pre-2Q speculation that the company would miss its earnings target," Borsch wrote on Thursday.

Borsch considers Aetna his third-favorite stock in the sector -- behind

Health Net

(HNT)

and

WellPoint

(WLP)

-- but maintains an in-line rating on the company due to an expected slowdown going forward.

Looking ahead to the second half, Aetna did in fact list a couple of items that will cut into bottom-line results. First, the company intends to spend $50 million -- double its original plan -- in preparation for new Medicare offerings that will kick off at the beginning of next year. Second, it expects interest expense to increase because of the termination of some interest rate swaps.

Following its strong first half, however, Aetna still managed to maintain its full-year guidance of between $4.52 and $4.57 a share. Still, hungry investors -- who have seen the company top estimates during a successful turnaround period -- were looking for 2 cents more than even the high end of that range.

But Borsch, for one, was not surprised by the outlook. He recently downgraded Aetna's shares in anticipation of a slowdown caused by both company-specific and industrywide challenges.

"We believe the extraordinary earnings momentum driven by Aetna's highly successful turnaround is likely to slow as it moves into the post-turnaround growth phase," Borsch explains. And "like other managed care companies, Aetna is facing a slowdown in core commercial product growth even as profit margins are likely approaching peak levels within the context of a gradual ratcheting up of competitive pressure across the historically cyclical health insurance industry."

In the meantime, Aetna continues to please. The company's shares rose 1.9% to $76 after Thursday's report.

Medicare Leader

Pacificare

(PHS)

-- a giant Medicare player being acquired by

UnitedHealth

(UNH) - Get Report

-- bounced on its quarterly update as well. The company's stock rose 1.1% to $75.69 after solid gains in both the company's Medicare and commercial business lines drove second-quarter results beyond Wall Street expectations.

The company saw second-quarter revenue jump by 18% to reach $3.6 billion and beat the consensus estimate by $100 million. Meanwhile, net income rocketed 22% to $92.6 million. And earnings per share jumped 20% to 95 cents, a penny above Wall Street forecasts.

"We are very pleased with the year-over-year increase in our earnings, which were ahead of consensus expectations even after including approximately $7.6 million, or 5 cents per share, in costs related to our Medicare Part D readiness and $4 million, or 3 cents per share, in out-of-pocket costs related to our previously announced agreement to merge with UnitedHealth Group," Pacificare CEO Howard Phanstiel said. "This earnings improvement was driven by higher senior membership, higher commercial membership and a 310-basis-point decrease in the commercial medical loss ratio."

In the company's senior division, revenue grew by 14% due to a 6% rise in membership and a 7% hike in premiums. The division's medical loss ratio did rise, however, as the company increased benefits in an attempt to increase its Medicare Advantage customer base. Nevertheless, the MLR of 87.5% still came in at the low end of management's guidance for the full year.

In the commercial division, revenue surged by 19% as a result of a 15% jump in membership and a 6% increase in premiums. Moreover, the division managed to lower its MLR because of improvements in both newly acquired and existing business lines.

PacifiCare's other division, which includes its pharmacy benefit management company, performed even better. There, revenue grew by 35% as a result of a big spike in business at the company's PBM.

Although Borsch voices some concerns about Pacificare -- specifically pointing to weaknesses in its core California market -- he ultimately sees great opportunities for the company ahead.

"We remain positive on the long-term outlook for Pacificare, as it remains the best-positioned name in the group on the Medicare growth opportunities for 2006," writes Borsch, who currently has no rating on the stock. Moreover, "Pacificare views our projection for 1 million seniors moving into Medicare Advantage plans in 2006 as conservative, as Pacificare expects the number could be higher."

Behind the Numbers

Like Pacificare, Aetna attributed its second-quarter growth to an expanded customer base and hikes in both premiums and fees.

During the latest quarter, the company increased medical memberships by 60,000 to more than 14.4 million overall. Meanwhile, premiums and fees jumped by 14% and 11% respectively.

Still, Borsch had expected more. Total enrollment just barely missed his forecast, while premiums and fees -- totaling $5.2 billion -- fell 2% short of his target. The company's MLR on the commercial portion of its business did match his expectations. However, the ratio for its Medicare business exceeded his forecast.

In addition, Borsch notes, Aetna's investment income of $257 million came in 12% lower than last quarter -- and his own projections -- costing the company 8 cents in per-share earnings. Moreover, he says, the company reported a slightly higher share count that subtracted another penny from results.

Aetna made up for those shortfalls in other areas, however. For one thing, Borsch says, the company's health care operating cost ratio came in lower than expected. For another, he adds, the company posted operating cash flow of $456 million that was some 44% above his own estimates.

Ultimately, Borsch concludes, "we remain constructive" on the company's stock.