Why Aetna Is Now a Bargain

Argus believes that the issues driving the Humana guidance cut, such as a wider-than-expected gap between bids on new Medicare Advantage contracts and the actual medical cost trend, which lowered profitability, can be resolved before the deal closes.

Ultimately the independent research firm thinks the sell-off in Aetna stock following the Humana merger announcement on July 3 presents a buying opportunity.

Going forward, the merger would create a more diversified company than the current Aetna. Based on projected 2015 numbers, the combined company would generate 34% of its revenue from the commercial business (versus a current 49%), and 56% from government businesses (Medicare Advantage, Medicaid and military).

The proposed merger makes strategic sense as it will combine Humana’s Medicare Advantage business, with 3.2 million members, and Aetna’s commercial business, with 19.9 million members.

As a result, Argus gave its investment thesis as:

We are reaffirming our BUY rating on Aetna with a target price of $130. We see a strong strategic fit in the pending merger between Aetna and Humana. The deal will combine Humana’s Medicare Advantage business, with 3.2 million members, and Aetna’s commercial business, with 19.9 million members. We note that the commercial business provides a pipeline for growth in Medicare Advantage plans as employees reach retirement age.

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Shares of Humana were up 0.8% at $187.66 on Wednesday. The stock has a consensus analyst price target of $201.63 and a 52-week trading range of $115.51 to $219.79.

Aetna shares were up 0.7% at $116.59, in a 52-week trading range of $71.81 to $134.40. The consensus analyst price target is $139.07.

Aetna shares have fallen 8.5% since July 2, the last trading day before the Humana merger announcement, compared to a 2.0% gain for the S&P 500 Health Care index. In the view of Argus, this pullback reflects the cut in Humana’s 2015 EPS guidance, rather than any revision in Aetna’s outlook, which has remained unchanged since the first-quarter earnings report.