Morningstar Expects WellPoint to Bounce Back from Market Drubbing

WellPoint (WLP) won a five-star recommendation from Morningstar this week. According to Morningstar analyst Matthew Coffina, WellPoint's economic moat is founded on its scale: it is the largest U.S. health insurer, with 35 million members.

With a dominant share of almost all of its markets, WellPoint can negotiate the best prices with health-care providers and pass those savings along to its members. Providers want business from its large customer base, while customers want access to its network of providers... Also, the company's costs (like investments in technology) are largely fixed, resulting in economies of scale that further secure its position as the low-cost provider.

Morningstar's Jeff Viksjo does however point out some risks to the stock's performance: Changes in state and federal regulation - a hot topic in this year's presidential election - could impact on the sector; and the significant portion of WellPoint's value invested in fixed-income and equity securities could lose value.

Coffina believes that the market overreacted to WellPoint's reducing its earnings guidance for 2008 because of a surprise increase in medical costs. As Viksjo reports:

WellPoint generally increases premiums ahead of medical costs and Coffina acknowledges that the current year was an underwriting mistake. However, while it's locked into insurance contracts for this year, the firm will get a chance to rebuild margins in 2009. With the stock trading at 7.5 times the low end of its revised earnings guidance, Coffina is confident that investors will be rewarded for sticking with WellPoint.

Morningstar concluded that WellPoint was an average risk stock, with a narrow moat, and, based on fair value estimates, closing prices, and cost of equity estimates as of Friday, March 28, it expects a three-year annual return of 40% on the stock.