Humana's High Expenses, Weak Cash Position Raise Caution

We issued an updated research report on Humana Inc. HUM on Aug 18, 2015.

Last month, the company reported second-quarter 2015 earnings that surpassed the Zacks Consensus Estimate but decreased year over year on deterioration in the Retail segment. The company has delivered negative earnings surprises in three of the last four quarter with an average miss of 3.58%.

Humana is set to be acquired by Aetna to form a combined company by the second half of 2016. On closing, Aetna will own 74% of the combined entity, while Humana will hold the remaining 26%.

Humana has been incurring higher-than-expected expenses owing to increase in operating, depreciation and amortization costs. Increased benefits have also been leading to deteriorating benefit ratios across most operating segments and the first half of 2015 was no exception. Humana needs to initiate cost management to avoid a negative impact on its financial position and pressure on its cash flow. Higher expenses may affect the financials in the long term due to capital erosion.

Moreover, the overhang of litigations continues to have an adverse effect on the company. Additionally, as mandated by the Health Care Reform Law, Humana has to pay health insurance industry fee, which is expected to increase further in 2015. This is definitely a headwind for the company's earnings.

Further capital expenditure for Humana has increased over the past few years, which combined with decrease in operating cash flows, has been weighing on free cash flow.

However, Humana's medical membership has been increasing for quite some time. Also, contracts for the Florida Medicaid business has led to a rise in state-based Medicaid membership in the first six months of 2015.  

Humana has been expanding its business platform over quite a few years. The company has developed various commercial products designed to provide choices to employers facing substantial premium increases due to medical cost inflation. Furthermore, the divestment of Concentra Inc., in the second quarter of 2015 is expected to help Humana focus on its core operations. The company also scores strongly with the credit rating agencies.

Humana currently carries a Zacks Rank #5 (Strong Sell). Some better-ranked stocks from the health maintenance space are Centene Corp. CNC, Health Net, Inc. HNT and UnitedHealth Group Incorporated UNH. All three stocks hold a Zacks Rank #2 (Buy).
 

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