WellPoint Sending Mixed Messages

The health care sector continues to stumble on problems like earnings quality and bad debt.
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The health care sector has pumped out stronger quarters.

As expected, hospital giant


(HCA) - Get Report

posted lower profits due to a surge in bad-debt expense. But two big drugmakers saw earnings fall as well.



actually swung to an unexpected loss, delivering its third quarterly earnings miss in a row. Meanwhile,


(MRK) - Get Report

posted a 5.3% profit decline -- but still topped the consensus by a penny -- after shedding its lucrative







, which toppled first-quarter estimates, stirred some concern on Wall Street. The California insurer reported a quarterly profit of $1.85 per share that beat the consensus estimate by 27 cents. But Goldman Sachs analyst Matthew Borsch quickly pointed out that underwriting margin gains -- responsible for much of the upside -- could prove unsustainable going forward.

"Earnings quality

was not as good as the earnings quantity," wrote Borsch, who currently has no rating on WellPoint's stock. "We are less bullish on WellPoint's first-quarter results than the huge EPS upside would suggest we should be."

The market celebrated anyway. Shares of WellPoint jumped 2.6% to $115.75 early Thursday morning.

Vital Signs

Following a profit warning last week, HCA posted first-quarter earnings of 69 cents a share, falling a penny shy of the latest consensus estimate. The company, which ranks as the largest for-profit hospital chain in the country, blamed a spike in bad debt provisions -- which shaved 26 cents from first-quarter earnings -- for the shortfall.

"Aside from the significant increases in uninsured-patient volumes and bad debts, results for the quarter were quite positive," stated HCA CEO Jack Bovender. "We were particularly pleased with the improved volume trends in both our inpatient and outpatient services. ... Long term, we remain confident that our existing assets, market locations and our reinvestment strategy will produce solid returns for our shareholders."

Investors showed some patience. Shares of HMA -- hammered after last week's warning -- inched up 25 cents to $40.35 on Thursday morning.

HCA did enjoy some decent growth in the latest quarter. Patient admissions, lifted by the acquisition of 11 hospitals, jumped 6.4%. Admissions increased 2.5% on a same-facility basis. The boost in admissions helped HCA grow overall revenue by 12.6% to match the consensus estimate of $5.9 billion.

Lehman Brothers analyst Adam Feinstein took some comfort in the volume turnaround.

"We note that this represents some major improvement from a year ago, when volumes were negative," wrote Feinstein, who has an equal-weight rating on HCA's stock. "There were a couple of positives from the

earnings announcement."

Feinstein pointed to a decline in malpractice expense as another favorable development. Still, he spotted a few negative surprises as well. Most notably, bad-debt expense -- totaling 11.7% of revenue -- was even worse than the company predicted last week. Feinstein, for one, remains concerned that HCA has been underreserving for bad debts in the past. He also questions why HCA is reporting even higher uninsured admissions than the rest of the industry.

"We do note a surprising(ly) large increase in the number of uninsured patients in the quarter, with uninsured admissions increasing 14% in the quarter and 19% in the month of March," Feinstein wrote. "This is likely a function of

HCA's focus on large urban markets, but the magnitude of this increase is hard to believe."

Another Miss

Less surprising, perhaps, was the latest earnings miss from Schering-Plough. The big drugmaker posted a nickel loss instead of the penny gain Wall Street had expected. But the company has delivered a series of negative surprises since one of its biggest prescription drugs -- allergy-reliever Claritan -- became available over the counter. The company is now relying on a new cholesterol drug, created through a partnership with Merck, to help fuel its turnaround. The new drug, Vytorin, has already received marketing approvals in both Germany and Mexico and is set for a U.S. launch in the second half of this year.

In the meantime, however, the company continues to struggle.

"Schering-Plough's first-quarter results reflect the serious challenges facing the company," acknowledged CEO Fred Hasson. "We are investing for the future even as we recognize that short-term comparisons may suffer."

The company's stock slipped 4 cents to $17.02 on Thursday's financial update.

Still, even a bearish analyst saw positives in the report. James Kelly of Goldman Sachs said that Schering-Plough's first-quarter revenue of $1.96 billion beat his own estimate. And he even viewed the company's spending -- which came in higher than expected -- as justified. He also predicted that the spending trend will continue for the next two years.

"We believe that it is the right prescription to fix a global R&D

research and development and marketing organization," Kelly explained.

For now, however, Kelly continues to steer his clients away from the stock.

"We believe that the turnaround and leverage will come," he stated, "but to a lesser degree than expected by consensus."

Weak Spots

Meanwhile, investors were apparently expecting a little more from Merck. The drugmaker's stock slipped 43 cents to $46.07 even after the company beat the consensus by reporting first-quarter earnings of 73 cents a share. However, the same company reported a profit of 76 cents a share when it still owned Medco, a major pharmacy benefits manager, a year ago.

Merrill Lynch analyst David Risinger was somewhat puzzled by the results.

"Merck missed our sales and operating income projections by a wide margin but dramatically exceeded our equity income forecast," wrote Risinger, who has a neutral rating on the stock.

Merck's first-quarter revenue inched up just 1% to $5.63 billion, falling more than $100 million shy of expectations. Meanwhile, Risinger noted, operating income of $1.9 billion was down 12% from last year. Equity income, which came in positive rather than negative, offset that shortfall.

In other health care action, WellPoint celebrated a 17% jump in revenue and a 43% hike in earnings per share. But the company weathered an unexpected enrollment decline in its core market of California. Borsch, for one, expressed some worry.

"In recent months, we have focused on California as a leading indicator for the industry," Borsch noted. "We see cautionary sector implications in WellPoint's below-expectations enrollment results in California."

Borsch also fretted about WellPoint's latest cash flow. He pointed out that cash flow, which essentially matched net income, came in well below the 1.7 times net income the company has averaged over the past four years. He did, however, acknowledge that cash flow took a modest hit from nonrecurring items.

For its part, WellPoint described the quarter as a solid one.

"WellPoint's continued focus on business fundamentals has resulted in another quarter where financial results exceeded expectations," the company stated. "WellPoint's excellent results reflect our commitment to offering a broad portfolio of innovative, choice-based products."

Analysts have taken a generally neutral view of the big insurer's shares.