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Aetna Shows Soft Spots, But Strength Overall

The usual outperformer merely meets estimates during a tough quarter for health insurers.

OKLAHOMA CITY -- Even

Aetna

(AET)

has shown some signs of weakness this earnings season.

After posting a string of upside surprises, Aetna merely met fourth-quarter expectations despite steady membership gains that continue to defy industry trends. Net income inched up just 3% to $448 million, while earnings per share of 88 cents simply matched Wall Street's target.

Aetna issued somewhat lackluster guidance as well. The company expects to report 2008 earnings of $4 a share -- 3 cents less than analysts' average forecast.

Aetna's stock slipped 53 cents to $52.75 following the company's update.

Still, Aetna offered better news than others in the health insurance group. For starters, the company increased its customer base by a solid 9.2% last quarter, expanding its commercial and government businesses alike. Importantly, the company managed to keep its costs under control as well.

Aetna's commercial medical loss ratio -- or the percentage of revenue spent on health care -- came in at 79.2% during the latest quarter. While the metric showed some deterioration from a year ago, when Aetna posted an MLR of 78.3%, it still hovered near the low end of management's own targets.

Citi analyst Charles Boorady had hoped for as much.

"In light of higher MLRs at

UnitedHealth

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and

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WellPoint

(WLP)

... medical cost trends (will be) important to watch in the fourth quarter," Boorady stressed in a note to his clients on Tuesday. But ultimately, "we view Aetna among the best operators and expect Aetna to have a clean quarter and re-instill confidence in the group following weak results" from its competitors.

Aetna's commercial MLR matched Boorady's target. But Boorady also had his eye investment income, an often overlooked metric that accounts for roughly 40% of Aetna's EPS. With almost 10% of Aetna's investments concentrated in mortgage loans, Boorady worried about possible fallout from the subprime mortgage crisis.

"There were no problem loans" at the end of the year, he wrote. However, "we think investors should remain attentive to any material negative changes in fair value given current credit market/sub-prime conditions."

In fact, Aetna saw its investment income slip 8.8% to $285 million in the fourth quarter. The company reported a $9.3 million capital loss as well.

With rumors circulating about a significant charge, however, the company's actual results proved reassuring in the end.

"There was no mention of investment write-downs for the quarter, likely removing a large source of worry," UBS analyst Justin Lake noted on Thursday. Indeed, "Aetna reported another in a line of strong, clean quarters this morning."

Both Lake and Boorady recommend buying Aetna's stock. Their firms have investment banking ties to the company.

When reviewing Aetna's latest report, Lake spotted multiple areas of strength. Perhaps most importantly, Aetna posted organic membership gains that far exceeded Lake's own estimates.

Aetna increased its commercial membership base by 4.8% during the fourth quarter, as it continued to steal market share in a fiercely competitive environment. The company bolstered that growth by expanding in the government arena.

During the latest quarter, enrollment in Aetna's new Medicare Advantage program jumped by a whopping 57%. Meanwhile, enrollment in the company's Medicaid plans grew more than five-fold.

For its part, Aetna has promised even better days ahead. The company aims to become the leader of the entire managed care group.

"That's our goal," Aetna CEO Ronald Williams stated on Thursday. Meanwhile, "we are very pleased to have delivered another year of strong results in 2007. Our disciplined focus on providing innovative products, integrated solutions and best-in-class customer service has resulted in consistent, profitable growth and a platform for continued success."