Investors had clearly hoped for a stronger outlook from Coventry Health ( CVH). They ignored Coventry's solid third-quarter results and instead hammered the stock on news of lower guidance. The shares tumbled 10% to $54 following Tuesday's quarterly update. To be fair, Coventry reported solid third-quarter results with help from an expanded membership base. Following its big merger with First Health, Coventry managed to boost revenue by 26% to $1.67 billion -- just shy of the $1.69 billion consensus estimate -- and match Wall Street's earnings expectations with profits of 81 cents a share. Net income rocketed 53% to $133 million during the period. Looking ahead, however, Coventry has warned that Hurricane Katrina could bring some future pain. Coventry derives 3.4% of its revenue from Louisiana, where it serves 76,000 customers -- the bulk of them in the greater New Orleans area. The company managed to escape the third quarter without a storm-related hit. However, it expects the hurricane to lower profits by as much as 5 cents a share in both the fourth quarter and the coming year. For 2006, Coventry now expects to post 2006 earnings of between $3.54 and $3.59 a share. Even with a projected 2-cent boost from Medicare opportunities, that total would fall shy of the current $3.64 consensus estimate. Analysts seemed a bit unfazed, however. Charles Boorady of Citigroup called Coventry's disappointing guidance "typical" for the company. And John Rex of Bear Stearns recommended buying the stock on any pressure Tuesday. "We believe that core operating fundamentals remain quite favorable," Rex wrote on Tuesday. And "we think there could be a near-term opportunity if (the) stock is weak on 2006 guidance points." Boorady, who also recommends buying the stock, continues to maintain his $68 target price on the shares.
Bright SpotsRex saw plenty to like about the quarter. For starters, he noted, Coventry managed to boost its core membership base more than he anticipated. The company itself was quick to celebrate that recent growth as well. "The Health Plan business continues to perform well, including growth of 39,000 members during the quarter," CEO Dale Wolf said. "And First Health continues to perform well both financially and operationally." Indeed, the First Health acquisition boosted overall results by 7 cents a share in the latest quarter. Coventry also posted a better medical cost ratio than many, like Rex, had anticipated. Prior to the company's report, however, Rex had suggested that the company could pull through with a positive surprise on this important metric. "We believe there could be room for further moderation," he admitted. "Moreover, we have to go back many years -- all the way to 1998 -- to find the last time that Coventry showed a sequentially higher MCR in the third quarter." Sure enough, Coventry's MCR of 79.3% beat Rex's 80.4% estimate. However, that gain was offset by higher selling, general and administrative expenses. Rex had also anticipated little impact from Hurricane Katrina. He acknowledged that Coventry derives 3% of its revenue from storm-ravaged New Orleans but portrayed half of the company's customers there as government employees who should not be hurt as much as those working for smaller employers. Going forward, Rex noted, Coventry has already pledged to grow earnings by 15% next year. For his part, Rex recently hiked his own forecast for the company's 2006 profits by 5 cents to $3.59 a share. However, he suggested that even his new forecast -- which still calls for some deterioration in the company's medical cost ratio -- could prove conservative.
In the meantime, he indicated that others might want to raise their expectations for the company as well. He voiced excitement about the company's Medicare opportunities in particular. "Looking into 2006, we continue to believe that Medicare Advantage provides a differential growth story for some in the group," Rex wrote last week. "With 12% of consolidated revenues derived from MA, Coventry shows as one of the more levered companies to the opportunity -- a factor that we believe is still underappreciated in the stock."