Cost Questions Swirl at UnitedHealth - TheStreet

Cost Questions Swirl at UnitedHealth

Investors are hoping the insurer can hold down medical costs.
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UnitedHealth (UNH) - Get Report is about to unveil the results of a key diagnostic test.

Investors reading Thursday morning's quarterly earnings report will focus on the health insurer's medical cost trends. Good news could rally support for a stock that has been stuck in the low $50 range for a year, while rival

Aetna

(AET)

has rallied.

But further deterioration in this crucial metric could spark fears of a chronic problem, after a recent spike in health care utilization.

"Ultimately, this report seems to be all about one metric: commercial MCR," Bear Stearns analyst John Rex wrote on Monday, referring to the medical cost ratio that measures the amount of each premium dollar spent on patient care.

"We view an 'in-line' result as critical to restoring confidence," Rex added. "The company has remained emphatic on the point that the December 2006 utilization issues ceased in January, a factor which would seem to make the sequentially flat

MCR guidance -- and even our lower outlook -- appear as imminently attainable, likely providing for significant relief in the stock if indeed delivered."

Rex expects UnitedHealth to hit financial targets with second-quarter earnings of 81 cents a share. He believes that the company will manage to boost its total enrollment, due largely to Medicaid gains in Tennessee, as well.

But Rex believes UnitedHealth should show progress on medical cost control.

"When we held meetings with CEO

Stephen Hemsley in late May, he noted that in 10 years in managed care

40 quarters, he has witnessed three instances, including

the fourth quarter of 2006, of inexplicable short-term spikes in utilization that never recurred -- this one, he believes, falling into that category," Rex says. "If

the fourth quarter of 2006 was in fact one of the extreme few quarters where a utilization spike occurred only to not reoccur again, the company's MCR projections, which include the increased utilization, could in fact prove conservative."

Rex is hoping for the best. He reiterated his outperform rating and $65 price target on UnitedHealth's stock ahead of Thursday's quarterly update. The shares inched up 13 cents to $53.08 on Tuesday.

Rex's firm has provided non-investment banking services to UnitedHealth in the past and hopes to secure investment banking business from the company going forward.

CIBC World Markets analyst Carl McDonald is bullish about UnitedHealth as well. Still, he recognizes that another MCR disappointment this quarter -- which he labels "the quarter of truth" for the company -- could put his outlook for the stock at risk.

McDonald believes that UnitedHealth's second-quarter MCR -- also known as medical loss ratio, or MLR -- will actually come in better than expected. But he does foresee some problems with that metric going forward.

"We're hard-pressed to explain what, if anything, has changed in the company's business to drive United's expectation that the third-quarter MLR can improve nearly twice as much as it has historically," McDonald wrote on Monday. "As a result, even if United reports a better-than-expected second-quarter MLR, we think the company will still have difficulty meeting its prior full-year MLR guidance."

Thus, McDonald feels that UnitedHealth could revise its MLR outlook when it reports second-quarter results this week. Still, while MLR setbacks have hammered the company's stock in the past, McDonald seems relatively unconcerned this time around.

"A deterioration in the full-year MLR seems to be widely anticipated in the market," he explains. "We may be in the minority here, but we think United's stock can work in this scenario."

McDonald has an outperform rating and a $60 price target on UnitedHealth shares. His firm hopes to secure investment-banking business from the company in the future.

Meanwhile, Rex continues to embrace the industry as a whole.

"Now entering year nine of margin expansion for managed care, a group that was supposed to run in only three-year cycles, clearly anxieties still run somewhat high -- a factor that, we believe, creates some opportunity," he states. "We ... see few other places in health care -- or the broader market, for that matter -- with a better relative valuation profile than managed care."