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Stock Analyst Update

Got Health Care? This Stock Is Poised to Gain 40%

Plus, three other firms that recently hit 5 stars.

Mentioned: , , ,

Following is a roundup of stocks that recently jumped to 5 stars. By way of background, we award a stock 5 stars when it trades at a suitably large discount--i.e., a margin of safety--to our fair value estimate. Thus, when a stock hits 5-star territory, we consider it an especially compelling value.

WellPoint, Inc.
Moat: Narrow | Risk: Average | Price/Fair Value Ratio*: 0.49 | Three-Year Expected Annual Return*: 40.0%

What It Does: WellPoint (WLP) is the largest U.S. health insurer by commercial enrollment, serving 35 million members. It holds the exclusive license to the Blue Cross and/or Blue Shield names in 14 states, including California, Georgia, New York, and Ohio. Traditional risk-based insurance products are complemented by non-risk-based plan management, pharmacy benefit management, disease management, and other services.

What Gives It an Edge: According to Morningstar analyst Matthew Coffina, WellPoint's economic moat is founded on its scale. 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. Coffina thinks this helps entrench and perpetuate WellPoint's competitive advantages over time. 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.

What the Risks Are: Changes in state and federal regulation could have sudden and unpredictable impacts on WellPoint's business. Health-care reform is a key issue in the upcoming presidential election, and all three candidates have proposed far-reaching changes that could hurt WellPoint if enacted. WellPoint's results could be harmed by regulation that limits the premiums it can charge or mandates the benefits it must provide, by decreased funding of Medicare and Medicaid products, or by new government programs that compete with its existing business lines. Also, a significant portion of WellPoint's value is invested in fixed-income and equity securities that could lose value, especially its $5.4 billion worth of mortgage-backed securities. Finally, managed care is a highly competitive industry, and battles over market share could lead to deteriorating underwriting standards that cut into WellPoint's margins.

What the Market Is Missing: WellPoint reduced its earnings guidance for 2008 because of a surprise increase in medical costs, and the stock plunged. Coffina believes the market overreacted. 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.

John Wiley & Sons, Inc.
Moat: Wide | Risk: Below Average | Price/Fair Value Ratio*: 0.82 | Three-Year Expected Annual Return*: 17.1%

What It Does: John Wiley (JW.A) is a global publisher of print and electronic products, with about 40% of its sales coming from outside the United States. The scientific, technical, and medical segment, which generates the highest profit margin, contributes about 44% of global revenue. The professional/trade segment includes a wide spectrum of categories and brands and contributes about 39% of revenue; Wiley's higher-education segment represents the other 17%.

What Gives It an Edge: Morningstar analyst Michael Corty credits Wiley with a wide economic moat, owing to its scientific, technology, and medical (STM) business segment. A majority of its customers are academic and institutional libraries that consider Wiley's STM journals and books to be must-have content, which is reflected by high renewal rates. For example, medical professionals rely on products like Dialysis and Transplantation in their research endeavors. The company often licenses its STM content with multiyear contracts. Furthermore, Corty believes its acquisition of Blackwell Publishing, a privately held British academic publisher, strengthens Wiley's economic moat in the STM business.

What the Risks Are: The company's higher-education segment faces two challenges. Funding cutbacks at public universities have led to lower admissions and the resistance to the high price of required textbooks has been an issue for several years. Second, the purchase of Blackwell Publishing required the company to increase its debt load.

What the Market Is Missing: Fresh off its $1 billion acquisition of Blackwell Publishing--the largest in Wiley's history--Corty believes the market is concerned about execution risk and is underestimating the long-term benefits of the Wiley-Blackwell combination. Corty points out that Wiley has a long history of making value-adding acquisitions and integrating them successfully. In addition to the cost savings associated with combining Wiley and Blackwell's infrastructure, salespeople, and other expense categories, Corty contends that the combined entity's top line will also benefit. For example, Wiley has been generating incremental sales by digitizing its older journal collection and making it available through Wiley's proprietary distribution Web site, Wiley InterScience. It's possible that some of Blackwell's older books and journal collections could be offered in digital form, adding an additional revenue stream in future years.

More New 5 Star Stocks
Public Service Enterprise Group (PEG)
Carpenter Technology Corporation (CRS)

* Price/fair value ratios and expected returns calculated using fair value estimates, closing prices, and cost of equity estimates as of Friday, March 28, 2008.

Jeff Viksjo does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.