Health Insurers Weathering Sickly Q1 Results

by Dan Burrows | May 3, 2012 11:43 am

Here’s a counterintuitive sign that the economy is improving: Some of the nation’s biggest health insurance companies are coughing up disappointing first-quarter earnings.

How can business look so bad if the economy is picking up steam? It works like this:

Health insurers set aside money to pay for claims as their customers avail themselves of benefits. In last year’s first quarter, cash-strapped consumers didn’t spend as much on health care, so that money instead flowed to the managed care companies’ bottom lines.

But personal spending on health care rose in this year’s first quarter. Costs rose as insurers paid out a higher portion of their incoming premiums for claims, leading a bunch of the biggest names to miss Wall Street’s forecasts.

Cigna (NYSE:CI[1]) was the latest insurer to miss estimates when it reported Thursday, joining a group that includes Aetna (NYSE:AET[2]), Coventry Health Care (NYSE:CVH[3]) and Humana (NYSE:HUM[4]). They all booted Wall Street profit forecasts this earnings season.

And yet health insurance stocks have been a solid call so far in 2012, especially when considering that they’re in a defensive sector that ought to be languishing as traders and investors have been embracing risk.

The Morgan Stanley Health Care Payor Index is up 9.3% year-to-date. The iShares Dow Jones US Health Care Providers (NYSE:IHF[5]) exchange-traded fund is up 8.8%. Yes, that lags the S&P 500’s 11.5% gain, but the managed care stocks are widely outperforming plenty of other defensive bets. For example, the utilities sector is off more than 1% on the year, according to S&P data. Consumer staples and telecommunications are trailing the broader market by a good 6 percentage points each.

The strong performance, however, has made it tough to find bargains among the biggest names.

That’s partly because health insurance companies have been hiking their guidance this earnings season, even when profit has come up short. Cigna lifted its full-year forecast Thursday even as earnings missed by 2 cents per share on higher costs. Since Wall Street cares more about the future than the recent past, that bodes well for the stock. CI is up nearly 11% year-to-date, but still trades at slight discounts to its own five-year averages on both a trailing and forward earnings basis, according to data from Thomson Reuters. That suggests the stock still has room to grow.

Less attractive are WellPoint (NYSE:WLP[6]) and UnitedHealth Group (NYSE:UNH[7]), both of which reported first-quarter results that exceeded Wall Street expectations and raised their annual forecasts.

However, shares in WellPoint have gained just 4% on the year and offer only slim discounts to their own five-year price-to-earnings averages — not the most compelling combination. UnitedHealth, meanwhile, has jumped nearly 12% in 2012, but that run has made the stock look a bit too pricey for value investors to initiate a long-term bet at current levels. Shares currently trade at about 10% premiums to their own five-year-average trailing and forward P/Es.

Humana, for its part, missed Wall Street’s profit forecast as first-quarter earnings plunged more than 20%, and its guidance was disappointing, too. That pressured shares, which are off about 4% for the year — and still don’t look like a bargain. Humana trades at fair value to its own five-year average on a trailing earnings basis and a premium of more than 10% by forward earnings.

Of the biggest names, Aetna currently looks like the best potential value play in an otherwise expensive sector. The company missed analysts’ estimates and didn’t raise its forecast, yet the stock still is holding on for a 6.5% gain in 20102. Meanwhile, shares offer bargain discounts of 20% to their own five-year averages by trailing and forward P/E, and AET also offers a modest 1.6% dividend.

As a group, managed care companies have provided surprisingly strong returns for a market that is so strongly in favor of offense this year. If stocks take a turn for the worse in the short term, health care should hold up better than the hottest sectors — and perhaps offer investors an opportunity to buy at more attractive prices on weakness.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

  1. CI:
  2. AET:
  3. CVH:
  4. HUM:
  5. IHF:
  6. WLP:
  7. UNH:

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