February 24, 2005
Ian Madsen, CFA
312.630.9880 x417
imadsen@zacks.com
Research Associate: Sunita Agarwal
Research Digest
www.zackspro.com
155 North Wacker Drive
Wellpoint Health Networks, Inc.
(WLP - NYSE)
Chicago, IL 60606
$120.95
Note to Readers: This report is substantially new material. Subsequent editions will have new or revised
material highlighted
Overview
Headquartered in Indianapolis, Indiana, WellPoint, Inc. (WLP or the Company) is the largest Blue Cross
Blue Shield Company in the country with approximately 29 million members in Ohio, Indiana,
Connecticut, Kentucky, Colorado, Maine, New Hampshire, Nevada, Virginia, California, Wisconsin, and
Georgia. In addition, the Company operates non-Blue branded products in 15 other markets. Like most
Blue Cross Blue Shield (BCBS) organizations, WellPoint has the top market share position in eleven of
the twelve state plans in which it currently operates. The Company offers a broad spectrum of quality
network-based managed care plans. WellPoint provides these plans to the large and small employer,
individual, Medicaid and senior markets. The Company's managed care plans include preferred provider
organizations, health maintenance organizations and point-of-service and other hybrid plans and
traditional indemnity plans. Its website is: http://www.wellpoint.com/
Investors in WLP should make an investment decision based on their assessment of the following issues:
Key Positive Arguments




WLP to experience growth of 12-15% in the next
year as the merger drives increased synergies
Management cited 20 new national account wins to
begin in 2005 adding approximately 250,000 new
members.
SG&A to decline by 220 bps to 15.0% in 2005 and
by 90 bps in 2006 to 14.2%.
Margins in the Specialty segment to expand over
time as the segment achieves economies of scale
following the merger.
Key Negative Arguments



The Company may face integration risk from the
merger of Anthem and WellPoint
Unexpected acceleration in medical cost trend may
lower the margins
The managed care industry is seen at a cyclical
peak, with business combinations expected to
account for significant growth going forward.
Of the fifteen analysts covering the stock, 93.0% gave a positive ratings and the remaining gave a neutral
ratings. There is currently no negative rating for the stock.
© Copyright 2003, Zacks Investment Research. All Rights Reserved.
Recent Events
On February 16, 2005 for the second time in two years, WLP’s executive vice president and chief
financial officer (CFO), David C. Colby, has been named the best chief financial officer in America for the
managed care sector by Institutional Investor magazine. This is Institutional Investor magazine's second
annual ranking of CFOs.
On February 15, 2005 WLP, announced that it has hired Susan E. Rawlings as President, Senior
Services, and Derek S. Bridges as President, WellPoint Dental. Rawlings will be responsible for all the
seniors business including operations, Medicare Advantage products and marketing plans for seniors for
several of WellPoint's brands. Bridges is responsible for the development of dental programs and the
delivery of dental products to WellPoint's various brands and business units.
On February 14, 2005 WLP, announced the launch of RxFrontier(SM), the first PBM-offered multidimensional education program for pharmacists nationwide. RxFrontier provides tools and training that
clinical pharmacists can use to help reinforce health management of patients by monitoring the
appropriate use of prescribed medication and follow-up on medication compliance in between patientphysician visits.
Sales
The Company reported total operating revenue of $6.7 billion in the fourth quarter, up 60.0% over the last
year as enrollment growth was greater than expected. According to one analyst (J.P. Morgan), the
Company is poised for another year of market share gains in 2005 following gains made by both
companies individually in 2004. Management guided to a growth rate of 4.0% in enrollment in 2005,
which should equate to the addition of over 1.1 million lives on an absolute basis. Management
mentioned that the Company has already signed up 20 new national accounts in 1Q05, so the national
accounts business should again be the growth driver in 2005. The analyst is currently projecting selffunded growth of 6.0% in 2005 compared with fully-insured growth of less than 2.0%, which should also
contribute to higher overall operating margins this year. The 4Q04 report also highlighted the strong
regional market share positions that the combined company controls following the merger. Specifically,
the analyst expects medical membership should exceed 9 million lives in both the West and Midwest
regions in 2005, and this type of local market share clout is unmatched in the industry and should provide
for an improved medical cost position in these markets as the company further leverages its increased
volume with the hospitals and providers.
The estimated revenue break up for the Company is as follows:
Zacks Consensus
Digest High
Digest Low
Digest Average
4Q04A
$6,724.4
$6,724.4
$6,724.4
Zacks Investment Research
FY04A
$20,462.3
$20,462.3
$20,462.3
1Q05E
$11,200.0
$11,409.0
$10,733.0
$11,210.9
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2Q05E
$11,373.0
$11,612.9
$11,248.0
$11,396.0
($ in Million)
FY05E
$45,240.0
$46,953.3
$45,240.0
$45,991.8
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Margins
Margins details are as follows:
Gross Margin
Operating Margin
Net Margin
2004A
24.8%
7.4%
4.7%
2005E
20.6%
8.4%
5.4%
2006E
19.9%
8.6%
5.5%
The Company reported net income of $184.5 million in the fourth quarter, down 23.8% from $242.0
million in the third quarter. According to one analyst (Bear Stearns), operating earnings increased 59.0%
from a year ago to $468.2 million, though were $16 million below his outlook as higher administrative
expenses more than offset the impact of a better MCR. The consolidated operating margin came in 20
bps below the analyst’s outlook, deteriorating 30 bps sequentially, to 7.0%. On a year-over-year basis,
the increase in operating earnings was driven by pricing to trend, enrollment growth, and administrative
expense synergies leveraged over a larger membership base. Operating earnings were below his outlook
by $16 million, on higher administrative expenses, offsetting the impact of a better MCR.
According to one analyst (Bernstein), the Company’s reported a 4Q SG&A ratio of 17.5% (including Mail
Order Drug) that was up 90bps from the 16.6% comparable ratio of last quarter (3Q04). This is likely
explained by increased spending necessary for the January 2005 renewal season. For full year 2005, the
analyst expects WLP’s SG&A ratio to come in around 14.8% (excl. Mail Order Drug cost), which is about
30bps below management’s guidance of 15.1% (excl Mail Order Drug) based on the analyst’s
expectation for greater deal-related synergies and core SG&A efficiencies from legacy Anthem. The
analyst’s 2005 SG&A ratio of 14.8% increases to 15.6% if Mail Order Drug cost is included in the
calculation.
For 2005, management stated on the earnings call that it anticipates premium yields and medical cost
trend to decline 100 bps each from the just under 10.0% experienced in 2004 from the combined Legacy
WellPoint and Legacy Anthem operations. Company sees reduction in rate of outpatient medical services
increases as driving the 100 bps expected decline in cost trend in 2005. For full-year 2005, management
noted component cost trend expectations as follows: inpatient (high single digit range), pharmaceutical
(around 10.0%), and physician (mid single digit range).
Earnings per Share
Quarterly EPS fell 59 bps to $1.69 in the fourth quarter from $1.70 in the previous quarter. Year over year
growth was 21.8% to $6.64 in fiscal 2004. GAAP EPS was $0.92 when including a one-time charge of
$0.47 per share for the repurchase of surplus notes, $0.31 per share in merger-related costs, and $0.01
per share in net realized gains, above management's prior guidance of $0.90.
Management reaffirmed prior EPS guidance of $7.75 for 2005, which can be conservative given that the
assumption includes $400 million of share buybacks, compared with projected free cash flow of $2.7
billion. One analyst (J.P. Morgan) estimates 2005 EPS at $7.75 and 2006 number at $9.10, projecting
operating EPS growth of over 17.0% in both 2005 and 2006.
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Forward and quarterly EPS estimates for WLP are as follows:
Fiscal Year Ended: Dec.
Zacks Consensus
Digest High EPS
Digest Low EPS
Digest Average EPS
Mgmt guidance
4Q04A
FY04A
1Q05E
2Q05E
FY05E
FY06E
$0.92
$0.92
$0.92
-
$6.10
$6.10
$6.10
-
$1.82
$1.88
$1.69
$1.82
-
$1.89
$1.97
$1.82
$1.91
-
$7.78
$8.05
$7.75
$7.82
$7.75
$9.16
$9.55
$9.00
$9.19
-
Target Price/Valuation
Bullish analysts believe that WLP deserves a premium valuation in comparison to its peers because
growth prospects continue to be very robust. The average price target for the analysts providing such a
number is $139.29. The price target ranges from $125.00 (Merrill Lynch) to $168.00 (Smith Barney). The
highest price is based on 18.0x 2006E EPS of $9.35 and the lowest price is based on 13.0x 2006 FCF or
13.9x 2006EPS. The median price target is $136.50. Few analysts (Goldman Sachs, J.P. Morgan, SG
Cowen) have not given their target prices. Most of the analysts have used the P/E multiple of the forward
EPS to arrive at their target prices. However one analyst (Legg Mason) has used the DCF method to
determine his target price. Please refer to the accompanying spreadsheet for individual analyst details.
Broker
Smith Barney
Merrill Lynch
Average
Price
$168.00
$125.00
$139.29
Multiple
18.0
13.0
-
Cash Flow and Capital Structure
Cash flow from operations for 2004 was $1.3 billion, or 1.4x net income and suggesting high quality
earnings. At 1.4x net income, the 2004 operating cash flow to net income metric compares to 1.5x net
income recorded in 2003. For 2005 and 2006, the Company sees operating cash flow of $3.0 billion and
$3.4 billion, respectively.
The debt-to-capital ratio rose just slightly from the third quarter to approximately 19.0%, which is down
from 20.0% on June 30, 2004 and 22.0% at year-end 2003 and is well below Company guidance of
24.0% post closing of the merger. This is a low level of indebtedness in absolute terms as well as
compared to other hospital stocks; a level below 40.0%-50.0% is generally seen as favorable while a
ratio of 60.0% or greater should be cause for concern. Low levels of debt allow WLP flexibility in the
decisions to make acquisitions, payoff debt, reinvest in existing hospitals, etc.
Long-Term Growth
The average long-term growth rate of the analysts providing such a number is 15.2%. Growth is
expected to be in the 10% - 15% range over the next 5 years. Clearly, this is premised on the acquisition
of WLP by Anthem proceeding smoothly. There is some skepticism that such a large entity will continue
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to grow at a double-digit rate, but the combined companies will represent the largest company in the
managed care industry.
Individual Analyst Opinions
The list below provides a highlight of relevant information from the most recent reports on WLP from the
analysts currently covering the Company. Please refer to the accompanying spreadsheet for specifics on
individual income statement projections (including sales and EPS), recent revisions to estimates, and
justifications for price targets provided.
POSITIVE RATINGS
Bear Stearns – February 8, 2005: Stock is rated Outperform with $135 price target.
The target price represents 15.0x to 2006 earnings estimate. The stock currently trades at 15.6x the ’05
and 13.2x the ’06 earnings outlook. The analyst believes that the Company possesses a number of
compelling investment characteristics, including, dominant market share, an attractive mix of ASO and
insured business, the powerful Blue Cross Blue Shield brand name. Moreover, he believes that the
Company will continue to post better organic member growth than most of the industry, in part as the
Blue Cross system continues to gain market share in the national/multi-sited account category.
Bernstein – February 8, 2005: Stock is rated Outperform with $133 price target.
The target price is based on 14.3x to 2006 EPS estimate of $9.30. The analyst rates the stock outperform
as he views the Company as one of the best in the managed care sector due to its large SG&A and
capital redeployment opportunities which implies EPS upside beyond guidance and consensus.
CSFB – February 7, 2005: Stock is rated Outperform with $145 price target.
The stock is currently trading at 12.7x the ’06 estimate a slight discount to the group at 13.2x and is
discounting only 8-9% operating profit growth over the next 3-5 yrs. The analyst believes that WLP will
experience growth of 12-15% over this period as the merger drives increased synergies and makes the
Company more attractive to national accounts, and as WLP capitalizes on its competitive advantages
with the new Medicare opportunity. These are only a few of the reasons that WellPoint remains the
analyst’s top pick for 2005.
Goldman Sachs – February 7, 2005: Stock is rated Outperform with no price target.
The analyst believes that the Company can outperform the group under a moderately unfavorable
scenario for the group in 2005 and perform at least in line under a moderately favorable scenario for the
group. He views a reasonable valuation with the stock trading at 16X the 2005 EPS estimate and 13X the
2006 EPS estimate, approximately in line with the group averages.
JP Morgan – February 7, 2005: Stock is rated Overweight with no price target.
The stock currently trade at a P/E multiple of 13.3 times the 2006 EPS estimate of $9.10, which is in line
with the commercial managed care group. Given the Company’s strong membership growth prospects,
leading market share positions, proven track record of execution, and diversified product portfolio, the
analyst expects the shares should trade to a 10- 20% premium to the commercial managed care group.
The analyst reiterates his Overweight rating on WLP shares.
Legg Mason – February 7, 2005: Stock is rated Buy with $150 price target.
The stock is currently trading at 15.5 the 2005 EPS estimate. The analyst views the Company's current
participation in Medicare as a fiscal intermediary and provider of managed care and Medigap products
positions the Company very well to grow the business.
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Lehman – February 8, 2005: Stock is rated Overweight with $139 price target.
The target price is based on 18.0x the CY2005 EPS estimate of $7.75 per share. This represents a 3.0%
premium to the current peer group multiple of 17.4x 2004 estimates, and represents a 15.0% premium to
its current multiple of 15.6 times.
Merrill Lynch – February 7, 2005: Stock is rated Buy with $121 price target.
The target price is based on 13.9x the 2006 EPS forecast.
Prudential – February 7 ,2005: Stock is rated Overweight with $138 price target.
The analyst believes that the Company’s scale and depth should produce earnings growth at the high
end of peer expectations. The Company should enjoy unmatched national account and large group
market share, new buyer power (over providers) and supplier power (over employers). With a full breadth
of products and wide geographic scope, Wellpoint will have significant revenue growth opportunities.
Consequently, the analyst thinks that the Company should command a forward P-E multiple of 15.0,
which will generate a share valuation of $138.
Raymond James – February 7, 2005: Stock is rated Outperform with $127 price target.
The target price represents a multiple of approximately 16.0x the 2005 EPS estimate of $7.78. The
analyst reiterates his Outperform rating, given the Company’s strong local market share and the ability to
realize significant cost and revenue synergies from the merger with Anthem.
Smith Barney – February 8, 2005: Stock is rated Buy with $168 price target.
The target price represents 18.0x the 2006 EPS estimate of $9.35. The Company currently trades at an
AEV/free cash flow multiple of 11.2x. The analyst believes that the Company should command a
premium due to its strong operations and long-term organic growth potential.
UBS – February 14, 2005: Stock is rated Buy with $143 price target.
The price target is based on 15.7 times the 2006 EPS estimate of $9.10.
Wachovia – February 7, 2005: Stock is rated Outperform with $129-138 price target range.
Based on the 2006E EPS of $9.20, the analyst arrives at a valuation range of $129-138. According to the
analyst, the risks to the valuation range, is an integration risk from the WLP deal and accelerating cost
trends.
NEUTRAL RATINGS
Williams Capital – February 9, 2005: Stock is rated Hold with $135 price target.
The target price is based on P/E of 17.1x to 2005 EPS estimate. The analyst states that the
fundamentals of the merged company is sound and projects that the Company will be able to meet
earnings estimates on organic growth.
NEGATIVE RATINGS
There are no negative ratings for the stock.
NO RATING
SG Cowen – Stock is not rated. No price target.
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