Coventry Health

(CVH)

could be facing a slowdown.

The managed care company -- which has enjoyed a healthy run for years -- faces mounting pressure in its largest market. State regulators continue to deny rate increases sought by nonprofit Blue Cross companies in Coventry's stronghold of Pennsylvania. As a result, Coventry could find it difficult to raise its own prices and remain competitive in that region.

Goldman Sachs analyst Matthew Borsch, who downgraded Coventry to underperform earlier this summer, cautioned investors anew on Thursday.

"Notwithstanding the nearly uniform chorus of bullish calls from the Street on CVH," Sachs wrote, "we expect pressure on CVH with intensifying price competition from both nonprofit Blues and public competitors."

Last week, Borsch noted, Blue Cross of Northeastern Pennsylvania became the latest nonprofit Blue in the state to see its application for a rate increase denied. The setback came even though the company has suffered an unfavorable shift in medical cost trends and could need excess funds to weather an industry downturn.

Nonprofit Blues operating elsewhere have faced similar rejections after years of price hikes that have left them with giant surpluses at a time when many customers are struggling to afford health insurance. Borsch calculates that two major Coventry rivals -- Pennsylvania nonprofit Blues Capital and Highmark -- have already exceeded the maximum surplus levels deemed appropriate by regulators. And he fully expects Coventry, whose shares have tripled over the space of two years, to suffer as a result.

"In light of these figures and concern over health coverage affordability," he wrote, "we expect continued regulatory, political and stakeholder pressure on both

nonprofit companies to use their surplus to reduce premium increases going forward that will contribute to a growing competitive headwind to CVH's enrollment and margin expansion strategy."

Earlier, both Merrill Lynch and Smith Barney seemed to downplay the challenges in Pennsylvania. At the very least, they felt that particular risk had already been priced into Coventry's stock. But the stock has risen more than 15% since the two firms raised it to buy in May, and at $50.18 on Thursday it already exceeds one of their target prices.

Merrill Lynch, which predicted the stock would go to $50, also assumed at the time that Highmark -- the largest of Coventry's Pennsylvania competitors -- would post a surplus within the recommended range. But Smith Barney seemed a little less comfortable with both Highmark's surplus and the situation in Pennsylvania overall.

"While we expect

the company to diversify its enrollment base away from Pennsylvania," wrote Smith Barney analyst Charles Boorady, "we still have concerns on its high exposure to the state."

Boorady expects Coventry to lessen its reliance on Pennsylvania -- which represents nearly one-third of the company's total enrollment -- by acquiring companies in other areas. But that could be tough. After acquiring more than a dozen managed care plans in the past five years, Coventry seems to be running low on attractive targets.

Borsch, for one, is concerned.

"We continue to see CVH's latest target -- a new market pure Medicaid health plan -- as a sign that commercial non-public acquisition targets are scarce, with fewer left, and other public managed care companies looking to be buyers," he wrote.

Borsch also noted that Coventry faces challenges outside Pennsylvania as well. He said that management itself has already admitted that it is "having a difficult time growing organically and pricing is tough" in its No. 3 market of Kansas City.

In addition, he said, management similarly confessed that last quarter's underwriting margins -- which pushed earnings ahead of expectations -- may prove unsustainable. He is now braced for negative surprises going forward.

Triple Threat
Coventry's two-year run

"With an industry downturn now at hand, we are skeptical on CVH key earnings growth drivers of underwriting margin expansion, organic enrollment growth and serial acquisitions of small health plans," Borsch wrote. And we "remain confident that competitive pressures will become increasingly apparent in CVH results and outlook over the next two to three quarters, per our downgrade two months ago."