UnitedHealth Sicker Than It Looks - TheStreet

UnitedHealth Sicker Than It Looks

Shares fall after commercial cost trends head higher.
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UnitedHealth (UNH) - Get Report still has some sore spots.

To its credit, the giant health insurer reported stronger quarterly results than it did last time around, when rising medical costs hammered the company's stock. But it continues to suffer in today's fiercely competitive environment nonetheless.

Second-quarter profits surged 22% to $1.2 billion, with earnings per share of 87 cents beating the consensus estimate by 6 cents, as the company's huge membership base grew ever larger.

Excluding special items, UnitedHealth's full-year earnings guidance has jumped to between $3.51 and $3.56 as a result. Analysts have been looking for 2007 profits of just $3.45 a share.

Still, UnitedHealth delivered some painful news in Thursday's positive update. For starters, the company reported first-quarter revenue of $18.9 billion that fell a bit shy of Wall Street expectations. More importantly, however, the company faces ongoing pressure in its lucrative commercial business and has become increasingly dependant on Medicare -- a likely target of future government cuts -- for its outperformance.

Notably, UnitedHealth saw membership fall and medical costs rise in its crucial commercial division last quarter. In contrast, the company posted higher membership and lower costs in its Medicare unit.

Instead of celebrating the Medicare boom, however, experts figured that investors would dwell on UnitedHealth's medical cost ratio in its commercial business -- which ticked up to 81.8% last quarter -- following the company's report.

"Given questions about the sustainability of Medicare margins in the current political climate, we believe more focus will be on the commercial business and would expect the shares to come under pressure this morning," Credit Suisse analyst Gregory Nersessian wrote on Thursday. But "we believe this scenario will create a buying opportunity, as we expect performance to improve in the second half of the year and into 2008."

Ultimately, Nersessian added, "we continue to believe UnitedHealth's diversified book of businesses positions the company well for the evolving managed care marketplace and reiterate our outperform recommendation" on the stock.

Nersessian values UnitedHealth shares, down 3% to $51.85 on Thursday, at $62 apiece. His firm has investment banking ties to the company.

Sheryl Skolnick, senior vice president of CRT Capital Group, feels more cautious on the name. Skolnick will need to see important signs of improvement in the company's commercial business, including favorable membership trends and clear pricing discipline, before she changes her "fair value" rating on the stock.

She has no position in the stock herself, and her firm has no investment banking ties to the company.

For now, UnitedHealth's latest results -- while far better than last quarter's disappointment -- have failed to offer lasting comfort to Skolnick. Specifically, she worries about another surprising jump in the company's commercial MCR down the road.

"I'm a little suspicious of the MCR for this year," Skolnick explains. "I'm still sort of holding my breath, crossing my fingers and hoping that they didn't make the same mistake twice."

Unfortunately, she says, investors must wait until early 2008 to find out whether UnitedHealth has properly estimated costs for its commercial products -- particularly consumer-driven plans with high year-end use -- and escaped the pitfalls that burned the company so badly this year.

Even if the company succeeds, Skolnick still worries about UnitedHealth's deteriorating business mix. Notably, she points out, the company continues to lose lucrative risk-based commercial accounts and rely on lower-margin fee-based accounts -- plus its explosive Medicare business -- for growth.

"It's getting tougher and tougher to make a buck in the commercial business, and that is UnitedHealth's core business," she stresses. "Consumers are saying, 'You know what? This is too expensive. No more.'

"So it's a good thing they have Medicare this year."

Rival

Humana

(HUM) - Get Report

, which focuses heavily on seniors, reported even stronger Medicare-related gains in a surprise preannouncement on Wednesday. The company's stock, down less than 1% to $67.74 on Thursday, set a new 52-week high as a result.

Yet some experts, worried about serious cuts to the lucrative Medicare Advantage program, wonder how long this boom can last. In fact, they fear that Humana's latest results could backfire -- and hurt the entire industry -- in the end.

"With Congress in the midst of contemplating major Medicare rate cuts, we didn't think it would be wise for Humana to show any real significant upside, since it would seem to give Congress even more ammunition to cut rates," CIBC World Markets analyst Carl McDonald wrote on Wednesday. "Humana, obviously, hasn't taken our advice."

McDonald has a sector-performer rating on Humana's stock. His firm seeks to do business with the companies it covers.