Humana Tops Q3 Earnings on Strong Segmental Performance
Humana Inc. 's HUM third-quarter 2015 operating earnings came in at $2.16 per share, surpassing the Zacks Consensus Estimate of $2.13. Results also soared 16.8% year over year from $1.85 per share in the third quarter of 2014 and were above earnings per share (EPS) of $2.15 that was guided by the company.
The improvement was driven by an increase in operating results from the Group and Healthcare Services segments as well as higher investment income related to repositioning of the investment portfolio. Additionally, increased share repurchase activity in the first half of 2015 led to a decrease in share count, which in turn boosted EPS.
Including costs associated with the proposed acquisition by Aetna, Humana's net income was $2.09 per share, higher than the year-ago income of $1.85.
Revenues at Humana for the reported quarter climbed 9.2% year over year to $13.4 billion. Higher premiums and services revenues in the Retail and Group segments drove the top line. Revenues, however, missed the Zacks Consensus Estimate of $13.55 billion.
Humana's consolidated benefit ratio, which reflects the percentage of benefit expenses in premium revenues, was 83.9%. This marks a deterioration of 60 basis points (bps) year over year. The year-over-year increase of the ratio largely stemmed from a rise in benefit ratios in both the Retail and Group segments.
Humana's consolidated operating cost ratio, which reflects the percentage of operating costs in total revenue less investment income, decreased 280 bps year over year to 12.8%. The improvement was primarily driven by a decline in ratios in the Retail and Group segments as well as the divestiture of Concentra in Jun 2015.
Quarterly Results by Segment
In Apr 2015, some of Humana's businesses were reorganized and renamed, per which the Employer Group segment was renamed Group segment. As a result, Humana now manages its business through three segments - Retail, Group and Healthcare Services. In addition to these, the company will continue to report results for those businesses which do not align with the reportable segments described above, mainly its closed block long-term care insurance policies, under the category of Other Businesses.
Retail Segment: The segment's pre-tax income decreased 6.1% year over year to $325 million. Higher benefit ratio more than offset the increase in Medicare Advantage membership and lower operating cost ratio, leading to the downside in the pre-tax income.
Reported premiums and services revenues surged 14% to $11.35 billion in the reported quarter. The upside primarily reflects a 12% year-over-year increase in average Medicare Advantage membership and higher membership associated with the company's state-based contracts and stand-alone PDP plans along with a high percentage of individual commercial business in ACA-compliant plans.
The benefit ratio was 86.1%, deteriorating from 84.9% in the prior-year quarter. This deterioration is attributable to higher-than-expected medical costs, lower Prior Period Developments and higher benefit ratios associated with a greater number of members in state-based contracts.
Operating cost ratio declined 70 bps to 10.9% in the reported quarter. This improvement was backed by administrative cost efficiencies related to higher medical membership and lower discretionary costs.
Group Segment: This segment of Humana generated pre-tax income of $39 million, significantly higher than $1 million in the year-ago period. This improvement came from a decrease in the operating cost ratio in the segment.
Benefit ratio was 82.4%, up 40 bps year over year, which reflects the impact of lower Prior Period Development. Operating cost ratio decreased 240 bps to 23.4% due to the loss of some large ASO accounts, and operating cost efficiencies related to the fully-insured business due to cost-reduction initiatives.
Reported premiums and services revenues increased to $1.82 billion from $1.81 billion in the year-ago period, primarily on the back of a rise in fully-insured commercial medical per member premiums.
Healthcare Services: Pre-tax income for the segment rose to $284 million from $203 million in the third quarter of 2014. The upside was attributable to higher revenues from pharmacy solutions and home-based services.
Revenues from this segment rose 15% year over year to $5.97 billion, mainly on higher utilization of the healthcare services businesses that led to an improvement in overall Medicare membership.
Operating cost ratio was 94.7%, down 70 bps. The improvement came on the back of higher profitability in the company's pharmacy business.
Humana's operating cash flow was $531 million in the first nine months of 2015, down from $1.43 billion in the year-ago period. Lower net income (excluding the gain on the Concentra sale) and an unfavorable impact of changes in working capital items mainly led to the downside.
As of Sep 30, 2015, cash, cash equivalents and investment securities of Humana were $10.90 billion, lower than $11.48 billion as of Dec 31, 2014.
The debt-to-capital ratio of Humana as of Sep 30, 2015 was 27.0%. This represents a 140 bps improvement from 28.4% as of Dec 31, 2014.
As of Sep 30, 2015, the company had $11 million outstanding under its commercial paper program.
On Jul 3, 2015, Humana declared that its will be acquired by Aetna, Inc. AET , which is currently one of the top three health insurers, to form a combined company. The combination of the two majors will position the new entity as the second-largest managed care company in the U.S.
The deal is valued at $37 billion or $230 per share and is scheduled to close by the second half of 2016.
Share Repurchase Update
In Sep 2014, Humana's board of directors of replaced the previous $1 billion share repurchase authorization with a new $2 billion program. The new program is scheduled to expire on Dec 31, 2016. The company bought back shares worth $329 million in the first half of 2015 and was left with shares worth $1.04 billion for repurchases. However, after the company entered the proposed takeover deal with Aetna, the share buyback program was suspended.
In Aug 2015, Humana's board of directors declared a cash dividend of 29 cents per share that was paid on Oct 30, 2015 to stockholders on record as of Sep 30, 2015. Humana paid cash dividends worth $43 million in the third quarter, thereby taking the tally to $129 million in the first nine months of 2015.
Per the company, although dividend payout will not be suspended for the deal with Aetna, the per share payout amount will not exceed 29 cents prior to the culmination of the deal.
The company expects fourth-quarter operating cash flow to be lower than the previously expected value due to delay in collection of risk corridor receivables associated with the 3Rs. Also, cash flow is likely to be affected by normal fluctuation in working capital balances.
Humana reiterated its 2015 adjusted EPS guidance at $7.75. The Zacks Consensus Estimate of $7.76 per share is pegged lower than the company's projection. Including gains from the sale of Concentra and estimated costs associated with the proposed transaction with Aetna, net income is expected to be $9.18 per share.
Performance of Other HMOs
Humana currently carries a Zacks Rank #3 (Hold).
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