UnitedHealth Affords View of HMO Struggles

This time around, quarterly checkups in the managed care sector could prove to be more than routine.

After a healthy two-year run, some fear, the industry may finally undergo a poor diagnosis. For now, many companies are expected to meet -- or even beat -- earnings expectations. But investors will be using next year's outlook to measure the sector's real health.

Prudential analyst David Shove views the upcoming quarterly update as especially important.

"This year, investors can no longer make the blind managed care group bet," stated Shove, who has a favorable outlook on the sector overall. "From the 2005 outlooks, investors will quickly realize which companies have the right stuff and which ones are faking it. ... Making the wrong choice will be painful."

Shove describes the second quarter -- when insurance deductibles have often been met -- as the toughest for managed care players even under favorable conditions. But he believes that some companies could face added difficulties this year. For example, he predicts that struggling players such as HealthNet ( HNT) and Humana ( HUM) will post second-quarter results that further "highlight their earnings weaknesses and challenges."

To be sure, however, Shove is far less concerned than some about a major industry downturn. He admits that "on the surface, the industry fundamentals appear to be slowly eroding." But he is convinced that strong national, and even some regional, players are nevertheless poised to continue their runs.

"Investor fears over soft employment growth, sustainability of premium pricing, rising government/regulatory risk and a surge in M&A activity have raised doubts over earnings growth prospects," he conceded. But "we think the managed care companies' 2005 outlooks will demonstrate that these fears are overblown."

Industry in Transition

Shove is looking for UnitedHealth ( UNH), which kicks of the industry's earnings season on Thursday, to set the tone for the sector. He believes the company will, once again, beat earnings expectations. He also expects the company to deliver a "more balanced, optimistic earnings outlook" than it did last quarter, when its concerns about commercial enrollment growth scared investors away. However, he does anticipate some uncomfortable news about the industry in general.


Saying Ahhhh
Managed care sector awaits second-quarter earnings
Company Reporting Date EPS Estimate* Year-Ago EPS
UnitedHealth (UNH:NYSE) July 15 $0.92 $0.71
WellChoice (WC:NYSE) July 22 0.71 0.59
Humana (HUM:NYSE) July 26 0.39 0.37
Anthem (ATH:NYSE) July 27 1.64 1.30
Aetna (AET:NYSE) July 29 1.66 1.28
FirstHealth (FHCC:Nasdaq) Aug. 2 0.32 0.38
HealthNet (HNT:NYSE) Aug. 3 0.50 0.63
Cigna (CI:NYSE) Aug. 4 1.25 1.13
Source: Yahoo! Finance. *Thomson First Call analyst consensus as of Monday.

"Altogether, UnitedHealth Group's outlook will assure investors of the managed care industry's favorable earnings outlook," Shove wrote on Monday, "but also remind them that the industry is in transition."

Goldman Sachs analyst Matthew Borsch has voiced more serious worries about the sector. For months, he has been cautioning investors about an industry downturn that could hurt all but the strongest companies. He points to pricing competition from the nonprofit Blues as a particular concern.

"We expect most companies will post solid earnings results this year," wrote Borsch, who has a neutral rating on the sector. "But we predict that strength in the stocks will be partly offset by intensifying concern over the 2005 outlook."

Still, even Borsch singles out big companies such as UnitedHealth as strong industry players. And he actually recommends buying Aetna's ( AET) stock.

Shove is less enthusiastic about Aetna, however. He predicts that the company will "post another strong quarter" but could fail to address investor concerns about the coming year. He, therefore, favors other companies like UnitedHealth instead.

Shove also likes Anthem ( AET) and WellPoint ( WLP), which are in the middle of a huge -- but hotly contested -- merger. He points to Cigna ( CI) and WellChoice ( WC) as good buys as well. He believes that Cigna will continue to show progress with its turnaround efforts, while WellChoice will deliver "another great quarter."

Pain Threshold

Shove reserves most of his concern for companies that are already hurting. He expects a "feeble" second quarter from First Health ( FHCC), which warned of a profit shortfall last time around. He also believes that HealthNet will disappoint investors again.

"We expect HealthNet's 2005 outlook will be a somber, realistic reflection of the painful turnaround process ahead," he wrote.

In addition, Shove predicts tough times from a company that -- for now -- is benefiting from the "financial windfall" created by the new Medicare law. He says that Humana could soon lose its "first mover advantage" as other players rush out with their own consumer-driven health plans.

Still, Shove does believe the new Medicare law -- which has boosted companies like Humana -- should remain relatively safe even if John Kerry, who is viewed as a threat to the sector, wins this year's presidential election.

"Kerry will unlikely impose Draconian funding cuts in the Medicare drug bill," Shove stated. "Despite the doomsday scenarios, a Kerry presidency would have a light-to-moderate effect on the managed care industry outlook."

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