Why Magellan Health Inc. Shares Decreased in Price Today

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of Magellan Health  (NASDAQ: MGLN  ) have stabilized at a loss of roughly 7% after plunging to a near 15% loss in early trading today. The sell-off was sparked by a disappointing earnings report that showed higher-than-expected compliance costs.

So what: Magellan, which recently acquired CDMI and Partners Rx, pointed to these two purchases as reasons for its revenue growth, which was up 5% year over year to $888 million for the second quarter. However, adjusted earnings of just $0.39 per share (excluding acquisition-related stock-based compensation and other one-time expenses) were far below the year-ago quarter's $1.15 in EPS. Analysts were expecting very slight top-line growth to $863 million, so Magellan came out ahead of that result, but it failed to reach Wall Street's EPS consensus of $0.57. The company blamed its weak earnings on "terminated contracts and unfavorable care trends" in its public-sector operations, particularly from the cost of care for behavioral-health issues. But its full-year guidance -- with an adjusted EPS range of $2.67 to $3.32 -- remains unchanged, as the company has plans to address its cost-of-care issues.

Now what: Today's drop merely brings Magellan's shares back to even for the previous year, but its dwindling earnings have pushed its P/E close to multiyear highs. On the other hand, the company's free cash flow is actually up quite a bit in its first two quarters this year as compared to the first six months of 2013, and as a result the company's price-to-free-cash-flow ratio is currently barely in the double digits, which is close to the lowest it's been since 2011. Magellan investors might be worried about future profitability, but the company is cheap enough on both a profitability and a free cash flow basis to potentially merit a closer look after today's drop.

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