Humana Inc. (HUM) reported its fourth-quarter operating earnings (excluding special items) of $1.65 per share, surpassing the Zacks Consensus Estimate of 80 cents. This also compares favorably with earnings of $1.48 in the year-ago quarter.
The operating earnings exclude the incremental expenses of $1.02 per share in the fourth quarter, partially offset by improved year-over-year performance in the company’s operations.
The incremental expenses in the reported quarter includes reserves strengthening for Humana’s closed block of long-term care business, incremental spending associated with the change in Medicare Advantage enrollment periods, the launch of the Humana Walmart-Preferred Rx Plan with Wal-Mart Stores Inc. (WMT), a contribution to The Humana Foundation, and transaction costs associated with the company’s acquisition of Concentra Inc.
In fiscal 2010, operating earnings were $7.18 per share, exceeding the Zacks Consensus Estimate of $6.57. This also compares favorably with earnings of $6.15 in the year 2009.
The results exclude the beneficial effect of 86 cents per share in higher-than-expected favorable medical claims development related to prior years, partially offset by the $1.02 per share of incremental expenses of the fourth quarter of 2010 and 55 cents in expenses from the write-down of certain deferred acquisition costs in the second quarter of 2010.
The better-than-expected showing was attributable to higher average Medicare Advantage membership, lower-than-normal commercial medical costs trends, and improved performance in the company’s operations.
On a reported basis, Humana earned 63 cents per share in the fourth quarter and $6.47 in fiscal 2010.
Behind the Headlines
Consolidated revenues for the reported quarter climbed 9.0% year-over-year to $8.35 billion, lagging the Zacks Consensus Estimate of $8.38 billion.
Revenues from premium and administrative services fees also increased 9% year-over-year on the back of growth in average membership for the health insurer’s Medicare Advantage plans and strict pricing across all lines of business. The increase was partially offset by lower average medical membership in the stand-alone Prescription Drug Plan and commercial fully-insured group plans.
Consolidated revenues for fiscal 2010 increased 9.0% year-over-year to $33.9 billion, exceeding the Zacks Consensus Estimate of $33.8 billion. Revenues from premium and administrative services fees also increased 9% year-over-year.
Government membership as of December 31, 2010, stood at 7,121,000, which reflected an increase of 3.6% year-over-year, while Commercial membership as of December 31, 2010, stood at 3,117,000, posting a decline of 8.6% year-over-year.
Total medical membership however plunged 0.4% year-over-year to 10,238,000. Humana’s Medicare Advantage membership at the end of the fourth quarter jumped nearly 16.8% from the prior-year quarter.
Humana reported selling, general & administrative (SG&A) expenses of $1.30 billion in the fourth quarter, up 16.9%, while benefit expenses increased 12.6% to $6.78 billion. Though depreciation plummeted 6.0% year-over-year to $57.1 million, other intangible amortization surged 2.9% to $9.2 million in the reported quarter.
In the year 2010, SG&A expenses were $4.66 billion, up 10.3%, while benefit expenses increased 9.3% to $27.09 billion. Depreciation increased 5.7% year-over-year to $225.1 million, along with a surge of 1.4% in other intangible amortization to $37.8 million in the fiscal 2010.
Pretax income from the Government segment in the reported quarter was $286.3 million with $1.65 billion in fiscal 2010. The Commercial segment witnessed a pretax loss of $111.8 million in the reported quarter, while fiscal 2010 posted pre-tax earnings of $101.6 million. Consolidated pretax income declined 56.2% year over year to $174.5 million in the quarter, while it increased 9.2% to $1.75 billion in the fiscal 2010.
Consolidated benefit ratio, which reflects the percentage of benefit expenses in premium revenues, jumped 260 basis points to 84.4% from the prior-year quarter, while it was unchanged at 82.8% in fiscal 2010 from the prior year.
However, it included a 70 basis point beneficial effect of higher-than-expected favorable prior-year medical claims development in the year 2010, partially offset by reserves strengthening for the company’s closed block of long-term care business. The consolidated benefit ratio shows the decline in the benefit ratios in the Commercial segment, with an improvement in the Government segment.
Humana’s consolidated SG&A expense ratio increased 1% to 15.7% in the current quarter, reflecting efficient scales of operations associated with higher average Medicare Advantage membership, along with continued focus on administrative cost reductions, offset by the incremental 4Q10 Medicare spending, the charitable contribution and the transaction costs of Coventry acquisition.In fiscal 2010, SG&A expense ratio was 10 basis points higher than 13.8% in fiscal 2009.
Evaluation of Capital and Balance Sheet
Cash flows used in operations were $47.4 million in the fourth quarter, as against cash flows provided by operations of $274.1 million in the year-ago period, due to lower net income year over year and use of cash associated with changes in working capital during the reported quarter. Cash flows from operations in the fiscal 2010 improved to $2.24 billion as opposed to $1.42 billion in fiscal 2009.
Humana exited the quarter with cash and cash equivalents of $1.67 billion and long-term debt of $1.67 billion.
During the year 2010, Humana repurchased 1,993,000 shares at an average price of $50.17, leaving approximately $150 million at the end of February 4, 2011 out of the $250 million authorized for repurchases in December 2009, which is effective until December 31, 2011.
As of December 31, 2010, Humana’s total assets were $16.1 billion and total shareholders’ equity was $6.92 billion.
Acquisition of Concentra
Humana acquired Concentra on December 22, 2010, which is a private health care company based in Addison, for $790 million in cash, in order to expanding its footprint into medical services nationwide.
Humana now expects its consolidated revenues for 2011 to increase in connection with this transaction. Concentra produces approximately $800 million of revenues annually from 240 workplace health-care facilities and more than 300 medical centers in 42 states.
Moreover, the acquisition of Concentra will increase Humana’s focus on its core businesses as a health care provider, besides providing revenue diversification and opportunities for strategic expansion over the longer term. Additionally, Concentra will provide access to Humana’s medical members in their certain geographic areas.
Apart from Humana, its competitor Cigna Corporation (CI) remains on track to grow its international business, and UnitedHealth Group Inc. (UNH) is focussed on earning revenues from several segments outside health insurance coverage.
Outlook for Fiscal 2011
With the closure of the acquisition of Concentra, Humana had raised its earnings per share guidance for fiscal 2011, and expected its earnings per share in the range of $5.45 – $5.65, from the previous outlook of $5.35 – $5.55.
However, with better-than-expected sales for the company’s Medicare Advantage and stand-alone Prescription Drug Plan (PDP) offerings during the recently completed 2011 open enrollment period as well as an increase in expected Commercial Segment earnings, led to an increase in the fiscal 2011 guidance to $5.70 – $5.90, up from its previous outlook of $5.45 – $5.65.
For the first quarter of 2011, Humana expects its earnings per share of $1.15 – $1.20, which includes an assumption of approximately 25 cents per share of expenses associated with the loss of the TRICARE South Region contract in early 2012.
Furthermore, the company expects its consolidated revenues to fall in the range of $36.5 billion and $37.5 billion in 2011, with consolidated investment income in the range of $350 million and $360 million, and consolidated other revenue in the range of $1.2 billion and $1.3 billion. Other revenues include the company’s Concentra operations.
Humana’s Medicare Advantage membership is expected to increase 90,000 to 110,000 from the year 2010, while Medicare stand-alone PDPs to increase 525,000 to 575,000 from the prior year. Humana’s Military services and Medicaid did not change from 2010.
Humana also anticipates the benefit cost ratio for the Government segment in the range of 85.5% to 86.5% and for the Commercial segment in the range of 78.5% to 79.5% for fiscal 2011. Humana expects the consolidated SG&A expense ratio within 14.5% to 15.0%, including Concentra operations. Excluding Concentra, Humana expects the consolidated SG&A expense ratio to be in the range of 12.25% to 12.75% for fiscal 2011.
Depreciation and interest expenses are expected in the range of $300 million to $310 million and $110 million to $115 million, respectively for fiscal 2011.
Humana also projects cash flows from operations in the range of $1.6 billion to $1.8 billion, while it expects capital expenditure to be approximately $280 million for fiscal 2011.
Our Recommendation
Even though the fourth quarter of 2010 results were favorable based on strong earnings from the Government segment, we remain concerned about the weakness in the Commercial segment, whose membership fell 8.6% year-over-year. Further, Humana’s better-than-expected sales in 2010 increased its Medicare Advantage and PDP membership growth estimates, which led to continued improvements in its operations.
With the acquisition of Concentra, Humana will also gain new opportunities in the growing area of health care. In addition, the deal will enhance Humana’s business, diversify its revenue stream and will provide opportunities for expansion.
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