Health-care benefits company Humana (NYSE:HUM) showed signs of life Monday when it bounced 6% on news that third-quarter earnings had beaten estimates by 18% and it was raising earnings guidance. In light of this news, Humana may be an example of a company whose improving fundamentals have been overshadowed by high-profile current events.
There are several factors that are worrisome now. First, there's the concern that Spitzer's latest probe may have adverse effects on the entire insurance industry. Consequences could include criminal proceedings, lawsuits against insurers from both customers and shareholders, or insurers being forced to change the way that they were doing business, hurting profits. However, much of Humana's business, such as contracts with the government and large corporations, seems unlikely to be affected by Spitzer's inquiries because typically these deals do not involve commissions.
A second concern is political uncertainty. While national security has been the foremost issue, the cost of health care and the importation of medication from Canada have also been discussed. When such issues become important, the profits of health insurers such as Humana can come under increased scrutiny.
A third concern is competition in the health insurer market. Humana has heaps of competitors, including Aetna (NYSE:AET), Anthem (NYSE:ATH), Sierra Health (NYSE:SIE), and Motley Fool Stock Advisor recommendations UnitedHealth Group (NYSE:UNH) and First Health Group (NASDAQ:FHCC). Plus, health insurance is close to being a commodity, which makes it difficult for any insurer to gain a competitive advantage or particularly high margins. Of these three factors, this one concerns me the most as an investor, as this difficulty is likely to persist indefinitely.
Yet despite these challenges, Humana's latest report is far from sickly. It reflects Humana's efforts to divest itself of nonprofitable business. Medical-expense ratios, defined as medical expenses divided by premiums, fell both sequentially and year-over-year. Profits per share also show nice sequential and year-over-year improvements.
The balance sheet, too, continues to look solid. As Sam Subramanian observed, Humana has loads of cash, which results in it having an enterprise value significantly lower than its market capitalization. Some of this cash is required to run the business, so it cannot be considered money that could potentially be distributed to shareholders. Nevertheless, the cash does result in Humana having an extremely healthy single-digit free cash flow-to-enterprise value ratio. And Humana is using the cash not required by the business in a very shareholder-friendly way: It's buying back shares.
Thus, investors not dissuaded by scary headlines might want to take a closer look at Humana.
Other Motley Fool articles on Humana and health insurers include:
Fool contributor Richard Gibbons, living in Vancouver, wonders whether he could export Canadian medications, but he doesn't own any stocks mentioned in this article.
