Little Relief for UnitedHealth

Investors at first cheered the managed care provider's plans to cut costs on July 2, but the shares wound up closing lower amid increasing concerns about its margins

By David Bogoslaw

That sound you heard on Wall Street on July 2 was a tentative sigh of relief upon UnitedHealth Group's (UNH) announcement that it was cutting its 2008 profit outlook by 16%—a move widely expected by investors—and slashing 4,000 jobs as part of a cost-cutting effort. The moves lifted shares of both UnitedHealth and the broader managed health-care group. Only later in the day did the challenges the industry faces in the next year or two come back into focus, causing the stocks to come off their earlier highs.

The Minneapolis-based health-care provider said it now expects adjusted earnings for the full year to be $2.95 to $3.05 a share, down from its prior forecast of $3.55 to $3.60 a share. The company also reduced its projection for cash flow from operations to nearly $5 billion from a previous range of $5.7 billion to $6 billion.

Separately, the company said it will pay about $912 million to settle two separate class actions filed over stock options backdating.

Chief Executive Stephen Helmsley cited smaller-than-expected gross margins from the company's commercial risk business, which serves employees enrolled in their company health plans, during the second quarter. It also said efforts to raise premiums have lowered enrollment so far this year, which has contributed to the lower earnings estimate.

A Sector on Hold

Talk began to spread among investors two weeks ago that a downward revision was coming when UnitedHealth declined to affirm its original earnings forecast after Coventry Health Care (CVH) slashed its full-year earnings outlook by nearly 17%. At that time, other managed-care providers such as Aetna (AET) and Humana (HUM) did reaffirm their initial profit projections.

UnitedHealth shares, which had been falling since the last week in May, traded as much as 6.4% higher before sliding back to close 2% lower, at $25.12, on July 2. Aetna also gave back earlier gains to end slightly lower, while WellPoint (WLP) and Coventry finished higher, albeit off their intraday peaks.

Thomas Carroll, an analyst at Stifel Nicolaus (SF) in Baltimore, attributed the short-lived rebound in UnitedHealth's stock to short-covering by investors who bet against the stock in anticipation of a reduced earnings forecast. "There's a feeling that it's not going to get any worse. Deep-value investors who have been waiting on the sidelines to get past this hurdle are starting to support this stock. We're seeing it across the whole sector," says Carroll, who has a "hold" rating on the entire sector.

Painful But Manageable Payments

Elimination of the concerns around the company's litigation exposure helped the stock price rebound temporarily. UnitedHealth said it will pay $895 million to settle a federal securities class action filed in December 2006 against the company and certain current and former officers and directors over backdating of stock options. The proposed settlement reached with chief plaintiff, the California Public Employees' Retirement System, and plaintiff class representative Alaska Plumbing & Pipefitting Industry Pension Trust in the class action will fully resolve all claims against the company, all current officers and directors named in the lawsuit, and certain former officers and directors named in the lawsuit, the company said in a news release.