Humana beats on earnings, guides higher. But profit-takers are out after recent all-time highs

Published Wed, Jul 27 202211:45 AM EDT

Club holding Humana (HUM) reported a better-than-expected second quarter before the opening bell Wednesday. Revenue increased 15% year-over-year to $23.66 billion, topping estimates on FactSet of $23.41 billion, and adjusted earnings-per-share increased 26% year-over-year to $8.67, exceeding estimates of $7.62. The earnings beat comes despite Humana's benefits expense ratio — also known as medical loss ratio, or MLR — coming in slightly above expectations at 85.8% versus the 85.3% consensus estimates. That, however, means a miss as lower is better here. Bottom line All in, a solid quarter with little to nitpick. The stock was actually down about 3.5% due to what we believe is a combination of profit-taking — given its recent run to all-time highs — and perhaps disappointment that management did not pass the entirety of the beat through to forward guidance. We believe Human's decision to use some of the second quarter's upside to increase investments in marketing and distribution to support Humana's improved 2023 Medicare Advantage (MA) product offering and support long-term growth to be the right call by management. Moreover, management remains on track to realize $1 billion in value creation with more upside in 2023 than previously expected. We'll go more on-depth on that later. Segment results for Q2 Humana's Retail Segment includes Medicare benefits — marketed to individuals directly or via group Medicare accounts, Medicare Supplement and state-based contract accounts. Retail revenue increased 13% year over year to $20.95 billion, driven by individual Medicare Advantage, membership growth in state-based contracts, and higher per member individual Medicare Advantage premiums. The benefits expense ratio in the quarter was 87%, in line with the year ago period. It reflected anticipated lower favorable prior period development that was partially offset by higher per member individual Medicare Advantage premiums and lower admissions per thousand associated with the individual Medicare Advantage business in the current year. Excluding the impact of favorable PPD, kind of like a core rate, retail's benefit ratio decreased, meaning improved, 60 basis points year over year to 87.2% from 87.8% a year ago. Humana's Group and Specialty Segment mostly consists of employer group fully insured commercial medical products and specialty insurance benefits marketed to individuals and groups. Group and Specialty revenue decreased 8% year over year to $1.58 billion, primarily due to the anticipated decline in fully insured commercial medical and administrative services only (ASO) commercial memberships, partially offset by higher per member premiums. The benefits expense ratio in the quarter saw significant improvement, falling to 76.3% from 82.6% last year. The improvement can be attributed to a higher mix of specialty products, which has a lower benefits ratio, as well as pricing and benefit design efforts to address Covid and improve profitability. Management also highlighted a less severe Covid impact on the fully-insured commercial business thanks to higher vaccination rates versus the year ago period. To this point, on the call management noted that despite an uptick in recent weeks, hospitalization rates remain lower than what was seen in prior surges. Excluding the impact of favorable PPD, the benefit ratio would have been 76.2% vs. 83.1% last year. Healthcare Services Segment includes pharmacy, provider, and home services along with other services and capabilities to promote wellness. Healthcare Services revenue increased 19% year over year to $8.96 billion and was driven by the impact of Kindred at Home revenues, strong individual MA and state-based contracts membership growth, which led to higher pharmacy revenue. Also helping was greater mail-order pharmacy penetration and higher revenue associated with growth in Humana's provider business. The segment's operating cost ratio — which is operating costs as a percent of total revenues less investment income — was 94.5%, down from 95.8% last year due to the consolidation of Kindred at Home operations, which has a lower operating cost ratio than the other businesses within the segment. The company's pharmacy operations had a favorable impact on the ratio as well. Raised outlook Management updated guidance for the full year 2022. Thanks to the strong start to the year and utilization of the Humana's core individual Medicare Advantage business running favorable to expectations, management raised its adjusted EPS outlook by 25 cents to "approximately $24.75," representing a 20% increase over 2021 results. Notably, this still includes an expected 50 cent per share Covid headwind in the second half, down from a full dollar. This guidance also accounts for a roughly 75-cent per share increase in marketing and distribution in the back half to support Humana's improved 2023 Medicare Advantage value and 65-cent per share dilution resulting from the pending divesture of its 60% ownership of Kindred at Home's hospice and personal care divisions. That's up from the 50-cent dilution previously forecasted. The divesture is expected to close in the current quarter. Value creation plan All signs point to management's $1 billion value creation plan being on track. On the call, the team noted they now have a line of sight to initiatives worth in excess of $900 million in 2023, up from the $575 million figure called out in April. They added they are confident in their "ability to fully deliver against the important commitment and ultimately realize $1 billion of value in 2023." Capital allocation Humana did not repurchase any shares in the quarter, leaving year-to-date number of shares repurchased at roughly 2.43 million at an average price of $411.32. The company currently has $2 billion remaining under its authorization. The stock was trading around $474 on Wednesday. Management still plans to use the bulk of the $2.8 billion in proceeds from the Kindred divestiture to pay down debt. (Jim Cramer's Charitable Trust is long HUM. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . 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