Sunday, November 21, 2010

The Long Term Case for Humana

As a result of the healthcare reform initiatives recently enacted, the health insurance industry is poised for fundamental change. We can be fairly certain about some things: Obamacare is the law of the land, Obamacare will not be repealed and, finally, Obamacare will be changed with the new Congress. Just what the changes will be and what the impact of those changes will be are anyone’s guess.

Humana Inc. (HUM) is a big player in this market. The Company is a benefits solutions company, offering an array of health and supplemental benefit products for employer groups, government benefit programs, and individuals. Humana operates in two segments: Government and Commercial. The Government segment consists of beneficiaries of government benefit programs, and includes three lines of business: Medicare, Military and Medicaid. The Commercial segment consists of members enrolled in its medical and specialty products marketed to employer groups and individuals. The Company provides health insurance benefits under health maintenance organization (HMO), private fee-for-service (PFFS) and preferred provider organization (PPO) plans.

Short-term, the greatest uncertainties are related to the Government segment of the business. The Company’s TRICARE contract with the government is expected to be extended for one year, through March 2012. There are no guarantees this contract will be extended this date. If it is not, Humana will book expenses related to the program’s termination.

The most significant uncertainty involves changes in the Medicare program. Humana is a big player in the Medicare Advantage program. Many health insurers are already closing Medicare Advantage programs and Humana is no exception. There will be consolidation within the industry and we expect Humana to benefit from this trend. Another trend is undeniable; the Baby Boom generation has begun applying for Medicare. This trend will continue for some years to come as the population continues to age.

Another strong point for HUM is its pharmacy benefits management business. This is an area that continues to demonstrate growth. We expect Medicaid reimbursement rates to experience downward pressure as states grapple with their own deficits. Medicaid is a huge cost for most states.

The Commercial segment is also in for significant change. Many smaller employers are dropping health insurance for their employees’ altogether. They find that paying the government a penalty for not providing insurance is less costly than providing insurance. This is an example of market forces at work.

The Company reported revenues of $8.42 billion for the quarter ended September 30, 2010 (3Q10). Humana’s revenue for the quarter ended September 30, 2009 (3Q09) was $7.72 billion. Earnings per common share (EPS) for 3Q10 is $2.32 and compared to $1.78 for 3Q09. Analyst projections for FY10 earnings range from $5.70 to $7.31 and average $6.91. The Company’s guidance is for EPS of $6.40 to $6.50, disappointing analysts.

Humana reports growth in revenues and operating profits across all segments of its business and reduced operating expenses. The balance sheet is reasonable. At September 30, 2010, the Company had cash, cash equivalents, and short-term investments of $11.54 billion, up 12 percent from $10.29 billion at June 30, 2010. The long-term debt to capital ratio is down to 19.4 percent in 3Q10 from 22.5 percent at FYE09.
The Company reports strong free cash flow. For the 3Q10, free cash flow per share was $6.77 as compared to $1.60 at 2Q10. Humana has a share repurchase plan in place. During 3Q10, the Company repurchased 968,000 of its outstanding shares. Approximately $150 million remains on the authorization.

There is a lot going for Humana as a mid or long term investment. The Company is well run, profitable and continues to grow. We think Humana offers a good opportunity for the patient investor.

Disclosure: Author has a long position in Humana.

Sunday, November 14, 2010

NeuStar Inc.: A Telecom Monopoly

NeuStar Inc. (NSR) is a telecom industry monopoly. The Company provides clearinghouse services to the telecom industry, making interoperability possible for competing communication service providers. It operates the authoritative directories containing all the phone area codes and numbers in North America, facilitates the routing of calls among competing providers, manages top-level Internet domain name services (.biz and .us), and administers U.S. common short codes (shorter phone numbers used for value-added services).
Unlike most monopolies, NeuStar does not seem to have a great deal of pricing power. There appears to be a history of the Company renegotiating contracts for lower rates. That being said, NeuStar is consistently profitable and maintains a very strong balance sheet.

In a press release dated October 28, 2010, the Company reported results for the third quarter 2010. 

Highlights from that release are as follows:

·         Revenue increased 11% from 3Q09 to $130.5 million.
·         Net income increased 22% from 3Q09 to $29.9 million.
·         Earnings per diluted share increased 22% from 3Q09 to $0.39.
·         EBITDA increased 16% from 3Q09 to $57.9 million, representing a 44% margin

·         Cash, cash equivalents and short-term investments totaled $377.5 million as of September 30th.
The Company reports for two operating segments: Carrier Services and Enterprise Services. Carrier Services include Numbering Services, Order Management Services and IP Services. The Enterprise Services segment includes internet infrastructure and registry services. The third quarter report shows revenue and earnings growth in both operating segments.

Historically, the Company shows consistency in its growth profile.

Growth %
3 Year
5 Year
Gross Income
Net Income
EPS Diluted

For the seven fiscal years ending 12/31/2009, the gross profit margin averaged 73.76%. In the twelve month period ending 09/30/2010, the gross margin was 77.00%. The seven year average operating margin is 29.77% as compared to 35.40% for the trailing twelve months. The net profit margin for the TTM 09/30/2010 is 21.30% whereas the average net profit margin for the prior seven fiscal years is 17.31%. Both operating and net margins have been strong during each of the past seven years with the notable exception of 2008.

EPS diluted have grown from $0.72 in FY05 to $1.34 in FY09. The lone exception is 2008 when EPS diluted declined to $0.06. For the TTM ending 09/10, EPS diluted rose to $1.47. There are ten analyst estimates for FY10. The estimates range from $1.50 to $1.54 per share. The analysts estimate FY11 EPS to range from $1.65 to $1.74; the consensus is $1.74.

The balance sheet is clean and strong. Cash, cash equivalents and short-term investments total $377.50 million as of September 30, 2010. On the other hand, total liabilities are reported at $114.9 million. Long term debt is $5.4 million. Current liabilities include $26.117 million in deferred revenue. The Company also books $8.923 million in long term deferred revenue. The current ratio is 5.1X and times interest earned is 116.6X. The Company should have no difficulties is covering their short term obligations. Return on equity and return on assets are 20.4% and 16.6% respectively.

NeuStar does not pay a dividend though the Company’s free cash flow of $1.44 per share could support one. NeuStar has in place a three year, $300 million share repurchase plan.

We think NeuStar has the potential to appreciate to $40 in the next twelve months.

Disclosure: The author has a long position in NSR.

Sunday, November 7, 2010

Brinker International: Challenge for Casual Dining

Brinker International, Inc. owns, develops, operates and franchises the Chili’s and Maggiano chains and has a minority interest in the Macaroni Grill chain of casual dining restaurants. The Company describes itself as “one of the world’s leading casual dining restaurant companies. With more than 1,700 restaurants and over 125,000 team members in 27 countries and two territories, Brinker and its brands welcome more than one million guests into our restaurants every day.”

Brinker’s recently announced results for the fiscal first quarter ended September 29, 2010.

Highlights for the first quarter of fiscal 2011 include the following:

  • Earnings per diluted share, before special items, increased to $0.21 compared to $0.12 for the first quarter of fiscal 2010 (see non-GAAP reconciliation below)
  • On a GAAP basis, earnings per diluted share increased to $0.21 from $0.15 in the first quarter of the prior year
  • Restaurant operating margin(1) improved 190 basis points to 15.0 percent
  • Total revenues decreased 6.0 percent to $654.9 million
  • Same restaurant sales at company-owned restaurants decreased 4.2 percent consisting of a 5.0 percent decrease at Chili's and a 1.4 percent increase at Maggiano's
  • Cash flows used in operating activities were $6.6 million and capital expenditures totaled $15.6 million
  • The Company repurchased approximately 5.3 million shares of its common stock for $92.7 million in the first quarter and repurchased an additional 4.3 million shares of its common stock for $83.1 million subsequent to the end of the quarter
  • The Company paid a dividend of 14 cents per share in the first quarter, an increase of 27.3 percent over the prior year quarter”

(1) Restaurant operating margin is defined as Revenues less Cost of sales, Restaurant labor and Restaurant expenses.

Brinker reports declining gross revenues at Chili’s. This is, at least in part, because the company shed 21 Chili’s restaurants in sales to franchisees and closed nine additional locations. Maggiano’s showed a 1.4% increase in same store sales due to increased traffic.

On the positive side, Brinker has consistently reported positive free cash flow. What is not so good is that free cash flow has been all over the place. Since FYE June 2004, free cash flow has ranged from a low of $0.11 per share to a high of $2.34 in FY10. For the trailing four quarters ending September 2010, free cash flow was $1.58 or 12X the recent stock price.

Depending on how you evaluate debt, we think Brinker has a problem. We find that long term debt is greater than working capital though it is a modest 3.26X free cash flow. The current ratio, at 1.0, is in line with the industry, as is times interest earned at 4.8X. Long term debt to equity is a heavy 80.4%.

The company’s long term growth rates are not impressive. Annualized seven-year growth rate for sales is negative at -1.3%. Similarly, the seven-year growth rate for EPS from continuing operations is -1.8%. Reported EPS for 1Q11 at $0.21 is 40% higher than for 1Q10 at $0.15. EPS for the trailing four quarters, at $1.21, is 42% higher than the year-ago period.

As previously mentioned, sales is a concern. In the quarter ending 9/10, sales were $654.9 million as compared to $778.1 million for the quarter ending 9/09. The TTM ending 9/10 has revenues at $3,513.5 million as compared to $4,054.5, year-over-year.

The company is widely followed by the investment community. Twenty analysts estimate earning for FYE 6/11 in the $1.28 to $1.45 and average $1.38. Some 18 analysts project FYE 6/12 earnings as being in the $1.38 to $2.19 range; the consensus is $1.63.

Brinker pays a dividend of $0.50 per share which provides a yield of 3.0%. This may be sufficient reason to hold Brinker a bit longer while the company gets its house in order.

Disclosure: Author is long EAT.

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