Molina Healthcare's Exposures

We are encouraged by Molina Healthcare, Inc.'s (MOH) continued diversification of revenue streams and management of medical costs in the second quarter, despite slightly higher general and administrative costs relative to premium revenue. Our Hold rating remains intact at current levels.

The company reported better-than-expected second-quarter net income of $16.5 million, or EPS of $0.59, compared with net income and EPS of $13.3 million and $0.47 a year ago. Key highlights of the result included a significantly lower medical loss ratio of 84.2% and a 4% sequential increase in enrollments.

The inability of the management to identify accretive acquisition targets is a potential limit to the company's future growth prospects. In addition, acquisition opportunities may necessitate expansion into states with less collaborative approaches to Medicaid managed care and less stable reimbursement regimes.

Moreover, reliance on state-sponsored programs increases the company's exposure to fiscal (state budgets and contract pricing arrangements) and political government agendas of the day relative to the commercial managed care organizations. This situation is further complicated in the State of California by the company's exposure to changes in provider schedule fees in its primary care clinic business.

The Molina family owns a major share of the company's stock, which accounts for the fact that the shares are relatively thinly traded. We have valued MOH on a forward price/earnings (P/E) basis, as well as a comparison to similar firms in the managed care sector. Our $28 target price is derived using a P/E multiple of 12.2 x FY08 EPS of $2.30.

Rockwell Facing Big Headwinds

Rockwell Automation, Inc.'s (ROK) third quarter EPS of $1.03 declined 3.7% from the prior-year quarter, due to increased investment spending and slower than expected growth in the U.S. and Europe.

For the full year 2008, the management expects revenue growth of 9%-10% in FY08, led by continued strength in Asia-Pacific and Latin America as well as in resource-based end markets, flat to low, single-digit organic growth rates in the U.S. and mid-single-digit organic growth in EMEA [Europe, Middle East, Africa]. We recommend investors Hold shares of ROK in their portfolio.

The company has a strong embedded customer base. Hence, it is well positioned to capitalize on the continued strength in the industrial automation market, which is likely to continue witnessing high levels of capital spending.

Another positive factor is the growth in the Logix open hardware architecture platform. The company has also been generating strong free cash flow. In the first nine months of FY08, ROK repurchased around 4.3 million shares for $251.7 million.