AET Aetna Inc. (delisted)

WellPoint Inc. (WLP) reported its first-quarter income from continuing operations of $891.0 million or $2.35 per share, surpassing the Zacks Consensus Estimate of $1.87. This also compares favorably with the income of $871.9 million or earnings of $1.95 in the year-ago quarter.

The improved showing was attributable to higher operating cash flows and the implementation of organizational changes in health care. Besides, the jump in medical enrollment also contributed to the increase.

WellPoint’s income from continuing operations excludes net investment gains of $35.6 million after-tax, or 9 cents per share in the first quarter of 2011; while net operating income in the first quarter of 2010 excludes net investment gains of $18.6 million after-tax or 4 cents per share, which was partially offset by an intangible asset impairment charge of $13.7 million after-tax, or 3 cents per share.

Including these one-time items, WellPoint reported a net income of $926.6 million or $2.44 per share in the first quarter of 2011 as opposed to $876.8 million or $1.96 per share in the prior-year quarter.

Behind the Headlines

Total operating revenues for the quarter came in at approximately $14.7 billion, lagging $14.8 billion by 1.3% from the year-ago quarter. However, it was marginally ahead of the Zacks Consensus Estimate of $14.6 billion.

The decline in revenues reflected lower Commercial operating revenue resulting primarily from the conversion of two large groups to self-funding arrangements during 2010, partially offset by revenue growth driven by increases in Senior, Federal Employee Program (“FEP”) and State Sponsored membership. 

However, it was pleasing to see a significant jump in medical enrollment during the reported quarter, with enrollment of 34.2 million members as on March 31, 2011, an increase of 1.1% from 33.8 million as on March 31, 2010.

Growth of members in the National business as well as growth in WellPoint's Senior, State Sponsored and FEP businesses contributed in the increase of medical enrollment. However, it was offset by membership declines in the Individual and Local Group businesses.

WellPoint posted a benefit expense ratio (benefit expenses as a percentage of premium revenue) of 82.1% in the reported quarter as against 81.8% in the first quarter of 2010, driven by higher medical costs and membership growth in the Senior and State Sponsored businesses.

Likewise, for Individual business, the benefit expense ratio increased as WellPoint complied with minimum medical loss ratio requirements in 2011. However, the Commercial segment faced a decline in benefit expense ratio, reflecting the conversion of two large groups to self-funding arrangements during 2010 and lower than anticipated medical costs in the first quarter of 2011.

On the other hand, the selling, general, and administrative (SG&A) expense ratio (SG&A expenses as a percentage of premiums, administrative services fees and other revenue) plummeted to 14.2% in the first quarter of 2011 from 14.6% in the year-ago quarter.

This represents a year-over-year increase of 40 basis points, reflecting a 4.5% reduction in SG&A expense resulting from lower personnel costs and the ongoing efficiency initiatives taken up by WellPoint, which were partially offset by a decline in operating revenue.

Segment Results

Commercial Business: Operating gains in the segment increased 15.0% year over year to $1.13 billion in the first quarter of 2011, owing to lower than anticipated medical costs in the Local Group business and a reduction in SG&A expense in the current year quarter.

Consumer Business: Operating gains in the segment plummeted 36.9% year over year to $205.8 million in the reported quarter, due to lower operating gains in the Senior and State Sponsored businesses owing to higher medical costs.

Other: Operating gains in this segment experienced an operating gain of $19.4 million in the first quarter of 2011, compared with an operating loss of $17.7 million in the first quarter of 2010. This was primarily driven by improved results in the National Government Services business of WellPoint and lower administrative expenses in the first quarter of 2011.

Evaluation of Capital Structure

WellPoint generated operating cash flow of $1.1 billion in the first quarter of 2011, while the company generated a net cash outflow from operations of $322.9 million in the first quarter of 2010 that included $1.2 billion of tax payments related to the sale of the NextRx pharmacy benefit management subsidiaries to Express Scripts (ESRX) in the fourth quarter of 2009.

At the end of March 31, 2011, cash and investments at the parent company totaled approximately $2.4 billion.

During the reported quarter, WellPoint repurchased approximately 11.4 million shares for $741.6 million. As of March 31, 2011, WellPoint’s board has $882.0 million remaining in its share repurchase authorization.

WellPoint also paid a quarterly cash dividend of 25 cents per share in the quarter, representing a distribution of cash totaling $92.8 million.

During the first quarter of 2011, WellPoint witnessed net investment gains of $54.7 million pre-tax, consisting of net realized gains from the sale of securities totaling $57.1 million, partially offset by other-than-temporary impairments totaling $2.4 million pre-tax.

In the prior year quarter, WellPoint experienced net investment gains of $28.7 million pre-tax, consisting of net realized gains from the sale of securities totaling $48.4 million, partially offset by other-than-temporary impairments of $19.7 million pre-tax.

Comparison with Competitors

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

WellPoint’s peer - Aetna Inc. (AET) is scheduled to report its first quarter of 2011 on April 28, followed by Humana Inc. (HUM) on May 2 and CIGNA Corporation (CI) on May 5.

Outlook for Fiscal 2011

WellPoint anticipates a net income of at least $6.70 per share, including net investment gains of 10 cents per share. This is an increase from the previous estimate of $6.30 per share.

Further, this outlook includes no investment gains or losses beyond those recorded during the first quarter of 2011.

In addition, WellPoint also anticipates year-end 2011 medical enrollment to be approximately 33.9 million members.

Operating revenue is expected to be approximately $59.9 billion for fiscal 2011, while operating cash flow is expected to be approximately $2.7 billion.

For fiscal 2011, WellPoint also expects its benefit expense ratio to be approximately 84.8%, with SG&A expense ratio to be approximately 14.2%.

Our Recommendation

WellPoint has a strong cash flow generation, leading market share positions, diversified product portfolio, proven track record of execution, attractive valuation, and consistency that would provide long-term value to its investors. Meanwhile, WellPoint has been increasing its premiums and controlling costs.

Further, WellPoint is well positioned among its peer group and has been strengthening its portfolio through its acquisition strategy, the synergies of which are expected to lead to margin expansion and top-line growth. Moreover, the sale of its in-house pharmacy benefits business to Express Script has strengthened its balance sheet and fueled buybacks.

Though we are pleased with the strong results of WellPoint along with solid capital management, we remain wary of the impact of the health insurance reforms and expect these reforms to likely overshadow the stock.

Currently, WellPoint carries a Zacks #2 Rank, which translates into a short-term Buy recommendation, indicating upward directional pressure on the stock over the near term.

 
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