3 Reasons WellPoint Inc Stock May Rise

One of the country's biggest healthcare insurers has an identity crisis. WellPoint, Inc (NYSE: WLP  ) plans to change its name to Anthem in a move to align itself with the name it attaches to the healthcare insurance plans it sells throughout the United States. That name change reflects the company's increasing focus on consumer-driven health as its business shifts away from insuring people through small group plans to plans sold through exchanges.

The advent of the Affordable Care Act and its auspicious goal of insuring more than 30 million previously uninsured Americans is having a seismic impact on the industry. With the second open enrollment period for plans sold on exchanges looming, let's consider three reasons investors may want to include WellPoint in their portfolios. But before that, it's important to emphasize that ther's no way to predict the future share price of the company -- outside bad news, a general market crash, and a host of other factors could weigh down the stock even if all three of these factors turn up in WellPoint's favor.

Source: WellPoint.

1. Exchange enrollment
Heading into last season's open enrollment, no one was sure what the impact would be on insurers' bottom lines.

The Affordable Care Act significantly hamstrung models used by insurers to understand the risk associated with insuring new members because it eliminates insurers' ability to price plans based on each individual's health (with the lone exception being cigarette use). That provision had many industry watchers worrying that insurers would fail to price plans high enough to offset the flood of new care demanded by millions of new members.

Now, with two quarters of data in the books, it appears that worries may have been overblown. According to WellPoint executives on the company's second-quarter earnings conference call, enrollment in exchange plans has tracked at, or better than, expectations. That means the amount of care demanded by these new patients hasn't surprised the company and suggests that pricing appears to have hit the mark in balancing cost-of-care and profit.

That's good news for WellPoint shareholders given that WellPoint was one of the most aggressive participants in the exchanges this past year.

The company's decision to offer exchange plans in 14 states allowed it to sign up 769,000 new members, far more than the 600,000 the company had previously predicted. That membership surge may prove the tip of the iceberg, however, given that the CBO estimates more than 25 million people will be covered by exchanges by 2017 (far more than the current number, roughly 8 million). If the CBO's estimates prove correct, premiums collected from a portion of these newly insured members could significantly boost WellPoint's revenue.

Source: CMS

2. Medicaid expansion
The ACA exchanges are going to have a big impact on WellPoint, but the federal and state exchanges aren't the only provision of the Act boosting WellPoint's business.

Reform also expanded Medicaid in 26 states, and private Medicaid insurers like WellPoint, which get paid based on the number of people enrolled in each state's Medicaid plan, are seeing Medicaid revenue climb nicely.

Exiting the second quarter, the number of people enrolled in private Medicaid plans run by WellPoint climbed from 4.5 million last summer to 4.8 million.

That 8.4% membership increase, driven primarily by Medicaid qualifications shifting to 138% of the poverty level in states embracing expansion, led to WellPoint reporting that sales in its government business, which also includes Medicare programs, grew 7.4% during the past year to $8.26 billion.

Medicaid expansion isn't just lifting WellPoint's sales, either. It's also boosting its earnings. In the first six months of 2014, the company's Government Business operating margin increased by almost a full percentage point to 3.4%. If those numbers hold up, sales tied to rising Medicaid enrollment should continue to support earnings through 2015.

3. Guidance proving too conservative
Uncertainty surrounding the Affordable Care Act prompted WellPoint to issue what appears to be overly conservative guidance last December.

Exiting 2013, WellPoint forecast that people enrolling in less-profit-friendly exchanges would pressure margin lower, resulting in earnings per share of at least $8. After the first quarter, WellPoint boosted that forecast to at least $8.40 per share. And coming out of the second quarter, the company has again increased expectations, guiding investors to expect it to earn at least $8.60 per share this year.

That's a significant bump up, but the company may not be done. During WellPoint's second-quarter conference call, the company used the term "conservative" more than ten times in describing its previous posture and guidance. That conservative approach to reserves suggests that if claims play out similarly to the first six months in the back half of the year, more could drop to the bottom line. If so, WellPoint's forward price to earnings valuation, which is hovering near its highest levels since 2008, would become more enticing.

WLP PE Ratio (Forward) Chart

WLP P/E Ratio (Forward) data by YCharts.

Fool-worthy final thoughts
There's no guarantee that healthcare costs in the third and fourth quarters will mirror results from the first and second quarters. Patients new to insurance will likely increase their use of it over time as they become more comfortable with it. If so, that could weigh down results. Even so, WellPoint appears to have conservatively modeled for such costs, suggesting that its guidance of at least $8.60 this year isn't likely to head lower. If that proves correct (or even, again, too conservative), then investors will want to keep WellPoint on their radar, particularly given that exchange and Medicaid enrollment are expected to grow, rather than shrink, next year, too. 

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