Balanced View on Humana - Analyst Blog

On Jun 19, 2014, we issued an updated research report on Humana Inc. HUM. We believe that the company's strong Medicare business, expansion of business platform and stable credit ratings position it to generate growth. However, rising expenses, overhang of litigations, competitive pressure and high debt levels are headwinds.

Earlier, Humana reported first-quarter 2014 earnings that surpassed the Zacks Consensus Estimate. However, results compared unfavorably with the year-ago quarter earnings due to the effects of sequestration for Humana's Medicare business that was absent in the first quarter of 2013, and higher expenses.

Humana has been performing well in its Medicare business that covers Medicare Advantage and Medicare Part D Prescription Drug Plan PDP contracts with the federal government. This business accounted for approximately 75% of total premiums and service revenues in the first quarter of 2014. Memberships have been increasing in this business for years. The raised membership guidance for 2014 further increases optimism.

Additionally, business platform expansion is expected to help this Zacks Rank #3 (Hold) stock generate more revenues going forward. The addition of the Kentucky Medicaid Contract, Florida LTSS contract and the Florida LTSS contracts, commencement of offering services in Illinois and Virginia in recent times further poise the company to strengthen its business platform.

Humana is also a financially sound company, which helps it to deploy its capital efficiently. This is evident from the 3.7% dividend hike and new share repurchase authorization in Apr 2014. The company also has strong ratings from credit rating agencies.

On the flip side, Humana has been incurring higher-than-expected expenses owing to increase in operating, depreciation and amortization costs. Additionally, higher drug cost trends around the hepatitis-C drug costs will likely lead to rise in overall expense for full-year 2014, thereby weighing on the company's margins. The overhang of litigations also continues to pressure Humana by increasing lawsuit settlement expenses and tarnishing the goodwill of the company. Moreover, Humana faces intense pricing pressure from competitors, particularly BlueCross BlueShield.

Additionally, Humana's high reliance on Medicare Advantage products is likely to adversely affect the company, particularly when the healthcare reform has reduced the selling season for the Medicare Advantage plans. Additionally, based on the CMS provided medical cost trend assumptions that relate to the Medicare Advantage funding changes in 2015, Humana expects Medicare Advantage funding to fall by 2%.

Other Stock to Consider

Investors interested in the healthcare services space could consider better-ranked stocks like Select Medical Holdings Corporation SEM, Centene Corp. CNC and WellCare Health Plans, Inc. WCG. While Select Medical and WellCare Health sport a Zacks Rank #1 (Strong Buy), Centene has a Zacks Rank #2 (Buy).