WellPoint Inc. (WLP) reported its third-quarter income from continuing operations of $701.2 million or $1.74 per share, surpassing the Zacks Consensus Estimate of $1.58. However, this compares unfavorably with the income of $850.5 million or earnings of $1.78 in the year-ago quarter.
The improved showing was attributable to higher-than-expected favorable reserve development and continued strong performance in administrative expense management.
WellPoint’s income from continuing operations excludes net investment gains of $37.9 million after-tax, or approximately 10 cents per share in the reported quarter, while it excludes net investment gains of $14.1 million after-tax or 3 cents per share and an impairment charge of $134.4 million after-tax, or 28 cents per share in the prior year quarter.
Including these one-time items, WellPoint reported a net income of $739.1 million or $1.84 per share as opposed to $730.2 million or $1.53 per share.
Behind the Headlines
Total operating revenues for the quarter came in at approximately $14.3 billion, exceeding the Zacks Consensus Estimate of $14.2 billion, while lagging the $15.2 billion revenues by 5.2% from the year-ago quarter. Almost 40% of this decline was attributable to the conversion of the large municipal group to a self-funded arrangement during the second quarter, with the remaining decrease coming from lower fully insured membership due to economic conditions and transfer of the UniCare business in Texas and Illinois.
The sale of the NextRx pharmacy benefit management subsidiaries to Express Scripts (ESRX) in the fourth quarter of 2009 also contributed to the decline.
It was also disappointing to see a significant decline in medical enrollment during the reported quarter, with enrollment of 33.5 million members as on September 30, 2010, down 1.1% from approximately 33.9 million as on September 30, 2009. Most of the decline occurred in the non-Blue business, due to the transfer of WellPoint’s UniCare members in Texas and Illinois to another Blue Cross & Blue Shield plan during 2010.
However, this decline was partially offset by the increase in the number of members in its Blue-branded Commercial and Individual products, Federal Employee Program, and in the State Sponsored and Senior businesses.
WellPoint posted a benefit expense ratio (benefit expenses as a percentage of premium revenue) of 83.8% in the reported quarter as against 82.1% in the third quarter of 2009, driven by the Senior and Individual businesses.
The Senior and Individual benefit expense ratio climbed on the back of the reduction in federal reimbursement rates for the Medicare Advantage program in 2010, and the delay in implementing rate increases in California. However, this increase was partially offset by an improvement in the benefit expense ratio for WellPoint’s Local Group business.
The selling, general, and administrative (SG&A) expense ratio (SG&A expenses as a percentage of premiums, administrative services fees and other revenue) plunged to 14.6% in the third quarter of 2010. This represents a year-over-year decrease of 30 basis points from 14.9%, reflecting lower administrative costs at WellPoint, due to the sale of NextRx and WellPoint’s ongoing efficiency initiatives, partially offset by implementation costs related to health care reform and the decline in operating revenue.
Segment Results
Commercial Business: Operating gains in the segment increased 21.2% year over year to $760.9 million in the third quarter of 2010 from $628.0 million.
Consumer Business: Operating gains in the segment plummeted 49.7% year over year to $261.7 million in the third quarter of 2010 from $520.0 million.
Other: Operating gains in this segment significantly plunged 87.2% from the third quarter of 2009, due to the sale of NextRx in the fourth quarter of 2009.
Evaluation of Capital Structure
WellPoint generated operating cash flow of $896.5 million in the third quarter of 2010. As of September 30, 2010, cash and investments at the parent company totaled approximately $2.9 billion.
As of September 30, 2010, WellPoint has $538.6 million remaining under its share repurchase authorization. The company expects to utilize this authorization in the fourth quarter of 2010, subject to market and industry conditions, with the completion of more than $4 billion of share repurchases during 2010.
During the third quarter of 2010, WellPoint witnessed net investment gains of $58.4 million pre-tax, consisting of net realized gains from the sale of securities totaling $61.6 million, partially offset by other-than-temporary impairments totaling $3.2 million. In the prior year quarter, WellPoint experienced net investment gains of $21.5 million pre-tax, resulting primarily from net realized gains from the sale of securities totaling $52.2 million pre-tax, partially offset by other-than-temporary impairments totaling $30.7 million.
Comparison with Competitors
Rival company Unitedhealth Group, Inc. (UNH) reported its third quarter results on October 19, 2010 with income from continuing operations of $1.14 per share, substantially better than the Zacks Consensus Estimate of 84 cents.
Another competitor of WellPoint, CIGNA Corporation (CI) also reported its third quarter results with profit from continuing operations of $1.10 per share on October 29, well ahead of the Zacks Consensus Estimate of $1.06.
Humana, Inc. (HUM) reported its third quarter earnings of $2.01 per share on November 1, well ahead of the Zacks Consensus Estimate of $1.67.
Outlook for Fiscal 2010
WellPoint anticipates a net income of at least $6.60 per share, including net investment gains of 18 cents per share recorded during the first three quarters of 2010, partially offset by the first quarter 2010 intangible asset impairment charge of 3 cents per share. This outlook does not include net investment gains or losses or asset impairment charges beyond those recorded during the first three quarters of 2010.
WellPoint raised its medical enrollment expectation to 33.3 million for fiscal 2010, consisting of 19.6 million self-funded members and 13.7 million fully insured members. WellPoint expected 33.1 million medical enrollments previously.
Operating revenue expectation is re-affirmed at approximately $58.0 billion for fiscal 2010.
For fiscal 2010, WellPoint currently projects an underlying medical cost trend in the range of 6.5%-7.5%. The underlying utilization would be lower than expected in 2010. Further, WellPoint believes that unit cost increases will continue to be the primary driver of overall medical cost trend.
The benefit expense ratio is now expected to be approximately 83.7% with the SG&A expense ratio at approximately 14.9% for fiscal 2010, as against the earlier projection of 83.9% and 14.8%, respectively.
Operating cash flow of WellPoint is now anticipated to exceed $1.2 billion in fiscal 2010, including the unfavorable impact of $1.2 billion of first quarter tax payments related to the sale of NextRx.
Our Recommendation
Though we are pleased with the strong results of WellPoint along with solid capital management, we remain concerned about the health reform headwind, which are expected to compress profit margins going forward. Moreover, concerns over continued high unemployment are likely to overshadow the stock.
WellPoint relies on growth through acquisitions and divests non-core assets. It has completed many deals over the past few years. The sale of NextRx has strengthened its balance sheet and fueled a major stock repurchase. It has, in turn, rewarded shareholders with significant returns on their capital. The acquisitions have also enhanced WellPoint’s financial standing with expanding margins and increasing top line.
Currently, WellPoint carries a Zacks #3 Rank, which translates into a short-term Hold recommendation, indicating no clear directional pressure on the stock over the near term.
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