Coventry Health Care Inc. (CVH) reported its first-quarter adjusted earnings of 66 cents per share, exceeding the Zacks Consensus Estimate of 53 cents.

Coventry’s adjusted earnings in the first quarter exclude the favorable impact of 8 cents from the Medicare Advantage Private Fee-for-Service (MA-PFFS) product. The Medicare offering stands discontinued from January 1, 2010.

Including the impact of this item, Coventry reported net income of $110.2 million or 74 cents per share in the first quarter as opposed to $97.3 million or 66 cents per share in the prior-year period.

The improved showing was due to solid performance across all lines of its businesses. Besides, continued emphasis on cost containment throughout the organization and excellent liquidity position resulted in positive results.

Behind the Headlines

Total operating revenues in the reported quarter climbed 6.6% year over year to $3.05 billion, same as forecasted by the Zacks Consensus Estimate of $3.05 billion.

During the first quarter, managed care premiums increased 7.2% to $2.76 billion, while revenues from management services jumped by 1.8% year over year to $293.6 million.

Coventry witnessed total operating expenses for the reported quarter of $2.88 billion, up 6.4% from the year-ago quarter. Medical costs, the major operating expense component, hiked 7.6% to $2.28 billion. Likewise, Coventry’s cost of sales, selling, general and administrative expenses (SG&A expenses) and depreciation and amortization (D&A) also increased over the said period.

Total membership in the quarter increased 6.0% to 4.6 million from the prior quarter.

Health Plan Commercial Group Risk: The Health Plan Commercial Risk membership for the reported quarter was 1,636,000, an increase of 135,000 from the prior-year quarter of 1,501,000.

Health Plan Commercial Risk premium yields in the reported quarter climbed to $320.97 per member per month (PMPM), up 2.9%. The Health Plan Commercial Group Risk MLR in the quarter came in at 80.2% unchanged from the MLR reported last year.

Medicare Advantage Coordinated Care Plans (MA-CCP): Coventry reported MA-CCP membership of 219,000, against 190,000 in the year-ago quarter, primarily driven by the acquisition of Mercy Health Plans (“MHP”) which closed on October 1, 2010. MA-CCP premium yields in the reported quarter plummeted to $883.09 PMPM by 0.2%. The Medicare Advantage MLR came in at 84.2%, compared to 82.7% a year ago.

Medicare Part D: Medicare Part D membership stood at 1,159,000 at the end of the reported quarter, against 1,600,000 in the year-ago quarter. Medicare Part D premium yields in the reported quarter climbed 3.2% to $90.86 PMPM. The Medicare Part D MLR in the quarter came in at 95.8%, against 95.3% in the prior-year quarter.

Medicaid Risk: The Medicaid membership at the end of the reported quarter stood at 468,000, which reflected an increase of 62,000 members from the year-ago quarter, largely driven by new markets in Nebraska and Pennsylvania during 2010. Medicaid premium yields in the reported quarter increased 1.0% to $221.16 PMPM. The Medicaid MLR in the quarter came in at 86.0%, against 84.0% last year.

Evaluation of Balance Sheet and Capital Structure

Coventry ended the quarter with approximately $1.36 billion of cash and cash equivalents. The company had approximately $750 million of deployable free cash at the parent in the reported quarter.

Furthermore, Coventry exited the quarter with $1.37 billion in long-term debt, with debt to capital of 27.3%.

During the quarter, Coventry paid $150.5 million into escrow related to potential litigation settlement made in February.

In addition, the company repurchased 1.7 million shares for $50.2 million during the quarter. Coventry’s board has increased the share repurchase authorization by 7.5 million shares. Currently, Coventry is left with the remaining share repurchase authorization of 11.0 million shares at quarter-end.

As of March 31, 2011, Coventry had total assets of $8.60 billion and shareholders’ equity of $4.27 billion.

Comparisons with Competitors

Rival company Unitedhealth Group, Inc. (UNH) reported first-quarter results on April 21, 2011. Income from continuing operations was $1.22 per share, substantially better than the Zacks Consensus Estimate of 89 cents.

Aetna Inc. (AET) reported first-quarter operating earnings of $1.43 per share on April 28, well ahead of the Zacks Consensus Estimate of 96 cents.

WellPoint Inc. (WLP) reported first-quarter results on January 26 with income from continuing operations of $2.35 per share, surpassing the Zacks Consensus Estimate of $1.87.

Outlook for 2011

For fiscal 2011, Coventry expects to earn between $2.65 and $2.85 per share.

Coventry projects risk revenue of $10.50 billion to $10.90 billion and management services revenue of $1.18 billion to $1.20 billion for fiscal 2011.

The company expects its consolidated revenue guidance to a range of $11.68 billion – $12.10 billion. Coventry’s consolidated MLR is expected between 81.9% and 82.5% in fiscal 2011.

Coventry anticipates cost of sales in the range of $264.0 million to $271.0 million, with SG&A expenses reiterated in the range of $2.00 billion to $2.04 billion, D&A between $136.0 million and $140.0 million, and interest expense in the range of $95.0 million to $102.0 million in fiscal 2011.

Coventry’s other income is expected to range between $74.0 million and $78.0 million in fiscal 2011.

Shares outstanding at year end 2011 are expected to be 147.0 million to 149.0 million.

Our Take

Coventry has a solid fundamental business and continues to grow with all seven core businesses performing at or above expectations. Further, we believe that Coventry is also growing on the acquisition front, as it is making continuous efforts to expand its footprint in Missouri and Arkansas.

Additionally, Coventry’s acquisition of MHP and its subsidiaries is expected to be slightly accretive to its 2011 earnings and will serve more than 1.2 million members in its six-state Midwest region.

We believe that Coventry’s acquisitive growth strategy will help it to leverage its regional service centers and improve operating efficiencies, largely through economies of scale.

We maintain a Neutral recommendation on Coventry in the long term. The quantitative Zacks #3 Rank (short-term Hold rating) for the company indicates no clear directional pressure on the stock over the near term.

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