Molina Healthcare Inc.

Transcription

1 February 10, 2015 Molina Healthcare Inc. Current Recommendation Prior Recommendation Outperform Date of Last Change 08/24/2014 Current Price (02/09/15) $50.48 Target Price $53.00 NEUTRAL SUMMARY (MOH-NYSE) Molina Healthcare s fourth quarter earnings surpassed the Zacks Consensus Estimate on increased memberships, higher revenues and enhanced administrative cost efficiencies. Financial position at 2014-end also remained strong with higher cash flows and increased assets. The company s ability to engage in inorganic growth initiatives and capital deployment also reflect an improved financial position. However, higher medical care costs are a dampener. Additionally, the adverse effects of enrollment delays and program execution as well as low interest rates raise caution for the future. Nevertheless, the ACA implementation is boosting membership, and premium revenues. We maintain our Neutral recommendation on the stock. SUMMARY DATA 52-Week High $ Week Low $32.73 One-Year Return (%) Beta 1.74 Average Daily Volume (sh) 574,546 Shares Outstanding (mil) 48 Market Capitalization ($mil) $2,423 Short Interest Ratio (days) Institutional Ownership (%) 80 Insider Ownership (%) 12 Annual Cash Dividend $0.00 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 18.8 Earnings Per Share (%) -1.4 Dividend (%) N/A using TTM EPS 29.0 using 2015 Estimate 20.1 using 2016 Estimate 15.2 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page Risk Level * Below Avg., Type of Stock Mid-Blend Industry Med-Hmo Zacks Industry Rank * 60 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) ,591 A 1,606 A 1,687 A 1,706 A 6,590 A ,069 A 2,312 A 2,484 A 2,801 A 9,666 A ,164 E 3,383 E 3,527 E 3,059 E 13,133 E ,407 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $0.64 A $0.34 A $0.31 A -$0.03 A $1.26 A 2014 $0.10 A $0.62 A $0.33 A $0.69 A $1.74 A 2015 $0.56 E $0.56 E $0.73 E $0.66 E $2.51 E 2016 $3.33 E Projected EPS Growth - Next 5 Years % Zacks Investment Research, All Rights reserved North Canal Street, Chicago IL 60606

2 RECENT NEWS Molina Healthcare Q4 Earnings Beat on High Enrolment Feb 9, 2015 Molina Healthcare reported fourth-quarter 2014 net income from continuing operations of $0.69 per share, handily beating the Zacks Consensus Estimate of $0.60 per share. Operational Update Total revenue in the reported quarter climbed 64.2% to $2.8 billion. Revenues were in line with the Zacks Consensus Estimate. The year-over-year upside in revenues was mainly driven by participation in the Medicaid programs that cover long-term services and supports (LTSS). Premium revenues improved 62.9% year over year to $2.6 billion, driven by enrollment growth. However, Molina Healthcare s service revenues decreased 0.7% to $53.6 million. Further, Molina Healthcare s investment income rose 23.5% year over year to $2.5 million. Premium tax revenues also increased 105.7% to $91.3 million in the fourth quarter of Total operating expenses rose 58.3% year over year to $2.7 billion. The rise stemmed from an increase in general and administrative (G&A) expenses ($204.5 million from $187 million), premium tax expenses ($91.3 million from $44.4 million), depreciation and amortization (D&A) costs ($25.1 million from $20.3 million) and medical care costs ($2.3 billion from $1.4 billion). Operating income was $33.9 million in the reported quarter, comparing favorably with an operating loss of $9 million in the year-earlier quarter. Additionally, Molina Healthcare s interest expenses increased to approximately $14.6 million from $13.8 million in the year-ago quarter. Further, medical care ratio (ratio of medical care costs to premium revenues) deteriorated 70 basis points to 89.4% from 88.7% in the year-ago quarter. Financial Update As of Dec 31, 2014, cash and cash equivalents at Molina Healthcare were $1.5 billion, up from $935.9 million at 2013-end. Cash from operations amounted to $1 billion in 2014 against $190.1 million in As of Dec 31, 2014, total assets increased to $4.5 billion from $3 billion at 2013-end. Meanwhile, Molina Healthcare s shareholder equity was $1 billion as of Dec 31, 2014, against $892.9 million as of Dec 31, Equity Research MOH Page 2

3 VALUATION The shares of Molina Healthcare currently trade at 20.1x our 2015 earnings estimate, at 12% premium to the 17.9x industry average. On a price-to-book basis, the shares trade at 2.5x, at 4% premium to the 2.4x industry average. The valuation on a price-to-book basis looks attractive, given the trailing 12-month ROE of 5.4%, which higher than the industry average of 0.8%. Our six-month target price of $53.00 equates to 21.1x our earnings estimate for With no dividend supplement, this price target implies an expected return of 5% over that period. This is consistent with our Neutral recommendation on the shares. Additionally, the quantitative Zacks Rank for Molina Healthcare is currently 3, indicating no clear directional pressure on the shares over the near term. Short interest is currently 12.1 days. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Molina Healthcare Inc. (MOH) Industry Average S&P WellCare Health Plans, Inc. (WCG) Health Net, Inc. (HNT) Magellan Health, Inc. (MGLN) Select Medical Holdings Corporation (SEM) TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Molina Healthcare Inc. (MOH) Industry Average S&P NA 2.1 NA Equity Research MOH Page 3

4 Earnings Surprise and Estimate Revision History Equity Research MOH Page 4

5 NOTE THIS IS A NEWS-ONLY UPDATE; THE REST OF THIS REPORT HAS NOT BEEN UPDATED YET. OVERVIEW Founded in 1980 and headquartered in Long Beach, CA, Molina Healthcare Inc. is a multi-state managed care organization participating exclusively in government-sponsored healthcare programs such as the Medicaid program and the State Children s Health Insurance Program ( SCHIP ), catering to low-income persons. The health plans are locally operated by wholly owned subsidiaries of Molina, each of which is licensed as a health maintenance organization, or HMO. Molina Healthcare derives revenues primarily from premiums paid to its health plans by the relevant state Medicaid authority. The premium revenues are jointly financed by the federal government and the states. The company also derives revenues from the federal Centers for Medicare and Medicaid Services ( CMS ) in connection with its Medicare services. Molina Healthcare was formerly known as American Family Care Inc. until it changed its name in Mar Effective Dec 31, 2009, Molina Healthcare terminated operations at the small Medicare health plan in Nevada. Molina Healthcare acquired the Health Information Management ( HIM ) business of Unisys Corporation on May 1, 2010 for $131.3 million. The acquired division now operates as Molina Healthcare Medicaid Solutions, a subsidiary of Molina Healthcare. Molina Healthcare Medicaid Solutions offers design, development, implementation and business process outsourcing services to state governments in Idaho, Louisiana, Maine, New Jersey and West Virginia. The subsidiary also provides drug rebate administration services in Florida. Molina Healthcare completed its acquisition of Abri Health Plan on Sep 1, 2010, for approximately $16.0 million. Additionally, on Dec 7, 2011, the company purchased Molina Healthcare Center, an office building in California, for $81 million. In 2013 the company acquired Lovelace Community Health Plan s contract for the New Mexico Medicaid Salud! Program, for $53 million. As of Sep 30, 2014, Molina Healthcare serves approximately 2.4 million members in 11 states. REASONS TO BUY One of Molina Healthcare Healthcare s subsidiaries Molina Healthcare of Michigan was selected by the Michigan Department of Community Health ( MDCH ) to participate in the Michigan Demonstration Program to Integrate Care for Persons Eligible for Medicare and Medicaid in Nov Enrollment for this program commenced on Oct 1, We believe this contract will help this subsidiary (membership totaling 238,000 as of Sep 30, 2014) gain more clients and bolster membership base. Effective Jan 2014, some of Molina Healthcare s major health plans were selected to take part in the dual-eligible demonstration projects of CMS. Among these in, the Medicare- Medicaid Plan ( MMP ) executed in California, Ohio and Illinois has started providing coverage to the dual eligibles since second-quarter Moreover, the company s health plans in California, Illinois, Michigan, New Mexico, Ohio and Washington have started participating in the Medicaid expansion effective Jan Also, the Managed Medicaid contract from the Grays Harbor Community Hospital and Harbor Medical Group announced in Jul 2014 should boost the payment received from the state for providing Medicaid services. During the same month, Molina Healthcare was chosen to participate in SupplierPay initiative, an alliance with the private sector to support small businesses by increasing their working capital. Going ahead, this achievement should strengthen the company goodwill and pave the way for writing more business. Equity Research MOH Page 5

6 Molina Healthcare has witnessed a steady increase in premiums and service revenues over several years in the past. Premiums account for a majority, while service revenues are the second largest component of revenues generated by the company. Also contributing to the increased revenues are more care intensive benefits and related higher premiums associated with the Aged, Blind or Disabled and Medicare members. Molina Healthcare s premiums increased at a three-year CAGR of 4.9% to $4.6 billion in Premiums further increased to $5 billion in the first nine months of 2014 compared with $2.2 billion year ago due to higher member months and revenues per member each month. Service revenues on the other hand represent the revenues generated by Molina Healthcare Medicaid Solutions, acquired in May Molina Healthcare generated annualized service revenues of $204.5 million in 2013, which increased at a three- year CAGR of 14.9%. Service revenues further increased 3.9% year over year to $156.4 million in the first nine months of Furthermore, with the approval of the Medicaid expansion in Ohio (fourth largest health plan in terms of enrollment), 54,000 new members became eligible for the program on Jan 1, 2014 and this is expected to surge to 300,000 by mid-2015, thereby improving enrollment and service revenues. In fact, Medicaid expansion in California, Illinois, Michigan, New Mexico, Ohio, Washington and South Carolina health plan contributed significantly to overall revenues during the first nine months of Owing to the implementation of the Affordable Care Act (ACA), effective Jan 2014, the company had nearly 20,000 Health Insurance Marketplaces members and added around 314,500 Medicaid members in the first nine months of As a result of the increasing premiums and service revenues, the company s total revenue has also been improving steadily since With the Medicaid expansion, dual eligible Medicare Medicaid plans and the provision of cost effective care at hand, Molina Healthcare s revenues are likely to increase in the upcoming quarters. Molina Healthcare has historically increased its membership base through the creation of new health plans and development of the existing ones, thereby increasing premium revenues. Aggregate membership increased 5.9% year over year to 1.8 million in 2012, 7.5% to 1.93 million members in 2013 and 23.8% to 2.4 billion in the first nine months of 2014, due to improvements across most of the health plans. The ACA also provides enough opportunities for further growth in membership. Additionally, the acquisition of the Lovelace Community Health Plan contract for the New Mexico Medicaid Salud! Program helped in driving membership. Also, Molina Healthcare gained members under New Mexico s State Coverage Insurance (SCI) program with Lovelace, effective Jan Molina Healthcare of New Mexico has the highest National Committee for Quality Assurance ( NCQA ) ranking among all the Medicaid plans in New Mexico. Additionally, in Sep 2013, Molina Healthcare of Michigan and Texas received an upgrade in rankings from NCQA for , boosting customer confidence and aiding higher enrollments going forward. The company is also moving toward having all its health plans accredited by NCQA for Medicaid in order to gain further memberships. The receipt of the NCQA accreditation by the Wisconsin health plan in Apr 2014 is in line with this motive. Moreover, its ability to offer certified Qualified Health Plans (QHPs) on the California Health Benefit Exchange and selection by Covered California should also boost its membership in California. Molina Healthcare has also signed memorandum of understanding (MoU) of Medicare and Medicaid programs with California, Illinois and Ohio. Going ahead, the consistent improvement in the membership base is expected to support top-line growth. Meanwhile, the company s health plans had an aggregate statutory and surplus capital of $798 million as of Sep 30, 2014, higher than the minimum requirement of $413 million. This reflects Molina Healthcare s strong capacity to support its health plans in future. Molina Healthcare has been expanding its geographic reach via acquisitions and adding to the consolidation of the industry. While the Health Information Management acquisition added value to Molina Healthcare s Medicaid health plan business, the acquisition of Abri Health Plan in 2010 brought in a vast exposure covering 23 counties in Wisconsin and approximately 28,000 Medicaid members. Moreover, the acquisition of certain assets of Community Health Solutions of America Inc. added around 137,000 members to the company s membership in Jan Moreover, the Equity Research MOH Page 6

7 acquisition of some assets from Healthy Palm Beaches Inc. (HPB) in Aug 2014 added 11,000 members to the Florida health plan. Additionally, the buyout of the Florida Medicaid Assets from First Coast Advantage in Aug 2014 added 63,000 members, thereby accentuating the operating scale and capacity to offer superior quality healthcare services. In addition, despite the cash outlays for inorganic growth, Molina Healthcare has a healthy balance sheet with a steadily improving cash flow. Operating cash flow increased to about $347.8 million in 2012 from $225.4 million in 2011 and $162 million in 2010, attributable to increasing operating efficiency as well as higher premium income, along with the impact of deferred revenues. Although cash flow from operations declined 45% to $190.1 million in 2013, it surged to $841.2 million in the first nine months of 2014 itself, also higher than cash outflow of $111.7 million in the year-ago period. A long-term trend of rising operating cash flow strengthens the cash position of a company and paves the way for efficient capital deployment. REASONS TO SELL Management remains cautious about the rising medical care costs, which are compressing margins. The increased expenses were the outcome of higher utilization and were most evident in connection with physician and outpatient costs. Influenza-related illnesses and costs associated with the more recently enrolled members were the key factors in the higher utilization. Medical care costs have spiked dramatically at a six-year CAGR of 17% from $2.1 billion in 2007 to $5.4 billion in It further increased 45.1% to $5.7 billion in the first nine months of Higher medical care costs have led to a surge in the medical care ratio as well. Although the medical care ratio declined in 2013, it again increased 310 basis points (bps) to 89.6% in the first nine months of 2014, reaching the company guided ratio for Moreover, high operating expenses continue to pose a risk to the company s operating leverage. Operating expenses increased at a four-year CAGR of approximately 16% to $6.5 billion in Expenses again increased 42.7% year over year to $6.8 billion in the first nine months of 2014, offsetting the surge in revenues, as reflected by the margins remaining under pressure. Any substantial elevation in operating expenses and medical costs could weigh heavily on margins, bottom line and cash flows going ahead. Investment income, a prime component of Molina Healthcare s revenues, has been declining since 2007, primarily due to low interest rates. This further declined by a three-year CAGR of 17% to $5.2 million in Although it improved in 2013 and in the first nine months of 2014, investment income remains vulnerable to the persistent low interest rate environment. As a percentage of revenues, it declined to mere 0.08% in the first nine months of 2014 from 0.1% in 2012 and 2013 and from 1.2% in If the low interest rate trend persists, we expect investment income as a percentage of revenues to keep declining in the future as well. We believe that Molina Healthcare needs to prudently hedge its investment portfolio from market fluctuations. The U.S. Health Care Reform Act passed in Mar 2010 aimed to expand coverage to 31 million uninsured Americans. However, the establishment of minimum medical loss ratios is increasing the costs of healthcare companies. Further changes, that are pending implementation, such as the ban on annual and lifetime coverage caps, annual fees on health insurance companies and excise tax on high premium insurance policies, will likely increase expenses. Moreover, the restriction on charging higher premiums from patients with pre-existing medical conditions should increase benefit expenses going forward. Additionally, the burden of an annual fee or excise tax by the ACA on health insurers (health insurance fee) effective Jan 2014 is likely to increase expenses for the company and weigh on its liquidity. Moreover, growth in premiums depends on the renewal of important Medicaid contracts. As witnessed in the past, loss of significant contracts due to intense competition adversely affects the membership base, cash flow as well as profitability of the company. Thus, Molina Healthcare always needs to be cautious about its contracts and needs to expand its presence in other states. Equity Research MOH Page 7

8 Molina Healthcare is exposed to losses related to delays in the enrollment and implementation of programs. Enrollment delays are impacted mainly by the execution of programs brought in by the state and federal government simultaneously. Delays in enrollment in the Illinois health plan, delayed start-up in the South-Carolina business and expansion into the Imperial County in Southern California are expected to increase administrative costs for the company going forward. On the other hand, delay in implementation of programs leads to a time extension where the company incurs administrative costs but as the program is not implemented it generates no revenues. For instance, the delay in the Illinois health plan from Feb to Mar 2014, along with the delays in securing agreements for reimbursement, increased administrative costs significantly. Any further delays are likely to weigh on the company s cash flow, which will make it difficult to meet the debt and liquidity needs going forward. DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of MOH. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1121 companies covered: Outperform %, Neutral %, Underperform 7.1%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Research Analyst Copy Editor Content Editor Lead Analyst QCA Rageshree Bose Meenakshi Sharma Meenakshi Sharma Tanuka De Equity Research MOH Page 8