July 1, 2010 / 2:12 PM / in 8 years

Analysis: Humana gains investor favor despite Medicare fears

NEW YORK (Reuters) - Investors are warming to Humana Inc (HUM.N), the large U.S. health insurer whose fate is inextricably linked to the massive Medicare government health program for seniors.

Humana’s dependence on Medicare Advantage -- the growing part of the program run by private companies -- has been a red flag. Under the new U.S. healthcare reform law, Medicare payments to insurers will be frozen next year and be reduced beginning in 2012. Many on Wall Street are worried about the future of private insurers’ role in Medicare.

That pessimism translated into a dim view of Humana’s growth prospects: Over the next five years, Humana is expected to post the lowest profit growth among its peers -- 1.9 percent a year on average compared to an average 7 percent for rivals, according to Starmine data.

But as Wall Street digests the health reform overhaul, Humana is becoming attractive. Humana is the lone large U.S. health insurance stock to rise this year: Through Wednesday, its shares had climbed 4 percent against an 11 percent drop for the S&P Managed Health Care index .GSPHMO.

“It’s a deep value story that’s beginning to resonate,” Sanford Bernstein analyst Ana Gupte said.

Analysts said Humana has gained allure as an investment partially because of the dawning realization of a more dour outlook under the new law for the traditional commercial health insurance business serving employers and individuals.

Humana and its main Medicare rival, UnitedHealth Group Inc (UNH.N), “are positioned to grow share and continue to do quite well with continued pressure on Medicare reimbursement,” Collins Stewart analyst Brian Wright said. “And that’s probably a more stable earnings stream for the foreseeable future than the commercial business.”

At a recent investor conference, Humana Chief Executive Officer Mike McCallister said, “With what’s happening with all of our lines of business as we look around our industry, Medicare is actually a very good place to be” -- a view he acknowledged as “counterintuitive.”

“Medicare is going to be a very big business in the future, we’re very well positioned,” McCallister said, “so we’re feeling pretty good about where we are.”


Medicare is seen as a growing market overall, particularly as the post-World War Two, U.S. baby boom generation is starting to become Medicare eligible.

Medicare enrollment overall is expected to swell from 46.8 million this year to 53.9 million by 2015, according to the report by the Medicare trustees.

“We know the market for the seniors is actually going to expand pretty significantly,” Raja Rajamannar, Humana’s chief innovation and marketing officer, said in a recent interview.

Overall enrollment in privately run Medicare Advantage plans also has been climbing, with the 11.1 million members this year more than twice as many as in 2004, according to the Kaiser Family Foundation.

Humana has 15 percent of the Medicare Advantage market, placing it second behind UnitedHealth’s 18 percent share, according to the Kaiser healthcare think tank. But while UnitedHealth is more diversified, more than 60 percent of Humana’s revenue comes from Medicare, and more than 80 percent of earnings, according to Stifel Nicolaus analyst Thomas Carroll.

Humana plans to stay a step ahead of the changes coming to Medicare Advantage. The Louisville, Kentucky-based company believes it can administer its plans at costs 15 percent below that of government-run Medicare, what it refers to as the “15 percent Solution.”

Humana touts its programs such as those that coordinate care for patients to eliminate unnecessary doctor visits, its networks that focus on physicians and hospitals found to be efficient, and voluntary member health assessments that can lead to cost-saving preventive care.

The insurer said it plans to plow that money back into better benefits and lower premiums for members as it seeks to make its plans more desirable and gain more share. Or the savings could shore up profits to counter reimbursement cuts.

Humana, along with UnitedHealth, is poised to snap up smaller companies unable to make investments necessary in the program, said John Gorman, chief executive of the Gorman Health Group, a consulting firm focused on government-sponsored health programs.

The number of Medicare Advantage contractors could fall from 700 today to about 500 by 2014, Gorman said.

    Although Gorman concedes that the industry’s reimbursement hit is a “big deal, especially when that industry lives on 2 or 3 percent margins,” he remains “very bullish” on the program, citing in part the growing senior population.

    “It’s a good program for companies to be in if they’re in it already and they’re good at it,” Gorman said. “This is going to be a real challenge for companies that are squishy on their commitment to the senior segment.”


    Other industry-watchers are less sure. BMO Capital Markets analyst Dave Shove rates Humana stock as “underperform” because of the company’s leverage to Medicare.

    “We’ve been negative on them mostly because this president has said that he doesn’t think anybody should make any money on the Medicare business,” Shove said.

    Whereas Humana now trades in line with the roughly 8 times earnings multiple for the health insurance group, Shove said Humana should trade a 1-2 mulitple discount. He thinks Humana will be challenged to meet its 15 percent cost savings goal.

    “If you talk to the doctors or the hospitals, nobody ever got rich on Medicare, so 15 percent below Medicare is pretty darn low,” Shove said.

    Gorman believes the large players may be willing to see their profits crimped in the next few years.

    “I think there’s a willingness, especially among the major players, to actually sacrifice a little bit of margin over the next couple of years in order to retain the membership,” Gorman said.

    “For those that are seriously committed to the senior segment, I think this actually lays out a very nice opportunity.”

    Reporting by Lewis Krauskopf, editing by Dave Zimmerman

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