Thursday turned out to be a very bad day indeed for investors in managed health-care provider Amerigroup (NYSE:AGP), a Motley Fool Stock Advisor recommendation. In a development that CEO Jeff McWaters termed "unexpected" -- but one that was presaged by a similar earnings warning and subsequent earnings report two months ago -- Amerigroup informed investors that its anticipated third-quarter profit of $0.48 per diluted share will not happen.
In its place, the company now expects to record a third-quarter loss of about $0.07. The reason? Shocker: Medical costs are rising. (Or hadn't you heard?) Actually, as bad as the high cost of health care is for you and me, it poses an even more serious problem for Amerigroup, which collects set fees from customers for its services, then uses those fees to pay its customers' doctors' bills, hopefully eking out a small profit along the way. Historically, Amerigroup has managed to pocket about a 4.3% net profit from its services -- small, but adequate. But as detailed in Wednesday evening's earnings warning, that profit margin has taken a serious beating this year as its customers increased their consumption of high-priced specialist, emergency, and neonatal intensive care.
In reviewing the bills it's now receiving for services provided in the first nine months of the year, Amerigroup has discovered that they're going to cost it about $46 million more than it had anticipated. Worse, the situation is getting, well, worse over time. Cost overruns appear to have totaled about $6 million in Q1, nearly tripled to $17 million in Q2, and are continuing to climb in Q3, when they're expected to hit $23 million.
Over the last three years, Amerigroup has reported $200.3 million in profits under generally accepted accounting principles. The company has generated $288.8 million in free cash flow -- 44% greater than the GAAP rules permit it to report as "profits." Today, that ratio looks likely to bite Amerigroup on the bottom (of its cash flow statement). If profits from services rendered in the first through third quarters decline by $46 million, that could translate into about $70 million in cash flowing out Amerigroup's doors as those bills come due. Unless Amerigroup finds a way to stem this tide of red ink, its free cash outflows for services rendered this year could trend toward $94 million. For comparison, that's more cash than Amerigroup generated in all of last fiscal year.
All of which suggests that, as bad as Wednesday's news was for investors who focus on GAAP, the coming quarters may look even worse for Fools who focus on cash flow. If that proves true, this already badly abused stock could have further to fall. My advice: Fools shouldn't rush in to buy, even on this Marianas Trench of a dip.
Side note: Foolish investors might want to take special notice of Amerigroup's higher costs for insuring neonatal care. That suggests that patients may be availing themselves of such services more than usual, to the benefit of a Motley Fool Hidden Gems watch list stock, NatusMedical (NASDAQ:BABY).
Fool contributor Rich Smith has no position in either of the companies mentioned here.
