I gotta admit, I have a soft spot for managements of companies that historically outperform, yet beat themselves up about how they could do better.
Managed health care company Coventry Health Care
Take a look at the results for the fourth quarter of 2004. They're hardly disappointing. Revenue climbed 13% to almost $1.4 billion, and operating earnings were up almost 32% to just under $92 million.
Coventry reported a variety of positive metrics for the December quarter. Membership was up more than 5% (though organic growth was weak), operating margins improved, and the company's medical loss ratio was better than a year ago.
Of course, the biggest news surrounding Coventry is the recently-completed acquisition of First Health (which was a Motley Fool Stock Advisor recommendation, meaning that Coventry is now a newsletter pick). Given the price that Coventry paid, the considerable differences in the operating philosophies of the two companies, and the troubled nature of First Health's business, Wall Street has not exactly been singing hosannas over the deal.
Nevertheless, Coventry management remains steadfast in the belief that they can realize significant benefits through the acquisition. In addition to cost synergies, Coventry believes that its greater size will increase its leverage in negotiating vendor contracts and enable it to grow its membership base more effectively.
While that may or may not be a viable premise, I do believe that simply importing Coventry's management should help the First Health business. Coventry has one of the best SG&A margins in the business, and that portends major potential for profit growth if it can bring the First Health businesses in line.
Of course, there are major risks as well. First Health and Coventry operates some very different businesses, and there's no guarantee that what worked for them individually will succeed when they're operating as a combined entity. What's more, First Health was in poor shape when Coventry took over, and it will take time to stabilize the business.
Finally, there's the question of scale. Prior to the close of the acquisition, Coventry was mostly a regional player. Now management finds itself at the controls of a business with a much larger footprint and the attending complications that go with that.
Although Coventry is admittedly a small fish in a big pond, and organic membership growth has been disappointing of late, current valuations may be over-discounting that. After all, this company does have one of the best returns on equity in the industry, and overall price competition remains sane. Trading at about 13 times EV-to-FCF and 16 times trailing earnings, Coventry is at least worth a second look for most growth investors.
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Fool contributor Stephen Simpson, CFA, has no ownership interest in any stocks mentioned.