UnitedHealth Group Inc. (UNH) Ready for the Storm — and Long-Term Success

There’s little doubt that the next couple of years will be “interesting” for UnitedHealth Group Inc. (NYSE:UNH). This giant health insurance, benefits, and health technology company has built its way to the top of the heap through strong management, ongoing M&A, and substantial reinvestment in the business, but the arrival of the Patient Protection and Affordable Care Act (commonly referred to as “Obamacare”) is going to significantly change the way health insurance markets operate for UnitedHealth Group Inc. (NYSE:UNH) and large peers like WellPoint, Inc. (NYSE:WLP) , Aetna Inc (NYSE:AET) , and CIGNA Corporation (NYSE:CI) . While most of the panic has worn off, investors may yet have a worthwhile long-term opportunity in this health care giant.

UnitedHealth Group Inc. (NYSE:UNH)

Watch and wait
Like CIGNA Corporation (NYSE:CI)  and Aetna Inc (NYSE:AET), UnitedHealth Group Inc. (NYSE:UNH) has been relatively cautious and conservative in participating in state exchanges at this point. While CIGNA Corporation (NYSE:CI) doesn’t have a long history of selling individual insurance in very many states, these companies have only decided to participate to the tune of single digits.

The motivation behind this caution is relatively straightforward — insurance companies are worried that only those most likely to use health care will be signing up right away, with healthier people staying away and choosing to pay fines instead. That makes it tricky to price these policies appropriately; while UnitedHealth Group Inc. (NYSE:UNH) has reams and reams of data on health care costs, trends, and consumption patterns, this is a new and different risk pool. So, they’re doing what most insurers do when faced with a new business — they’re wading in slowly.

There’s really not much for UnitedHealth Group Inc. (NYSE:UNH) to lose here by waiting. Rivals like WellPoint, Inc. (NYSE:WLP)  are participating more aggressively, mostly to maintain their Blue Cross Blue Shield businesses in 14 states, but I do not believe there will be all that much loyalty in these exchange-based products . If and whenUnitedHealth Group Inc. (NYSE:UNH) steps in later, I believe customers will evaluate them on the price and features of their plans, not on whether they were there from day one.

A fringe benefit to Medicaid?
The ACA enrollment process may also end up benefiting UnitedHealth Group Inc. (NYSE:UNH) in a couple of ways that were not part of the original plan. The one-year extension on plans that would otherwise be canceled shouldn’t do UnitedHealth Group Inc. (NYSE:UNH) any harm, as the plans were profitable for them.

Medicaid may also end up being an unexpected benefit to UnitedHealth Group Inc. (NYSE:UNH) in this process. A surprisingly large number of people using the Health Exchange website have discovered that they are eligible for Medicaid coverage. As the second-largest administrator of Medicaid plans, that means more potential covered lives (and more revenue and profits) for UnitedHealth Group Inc. (NYSE:UNH), as well as market share leader WellPoint, Inc. (NYSE:WLP). Medicaid is not as much of a driver for CIGNA Corporation (NYSE:CI) and Aetna Inc (NYSE:AET), though Aetna Inc (NYSE:AET)Aetna Inc (NYSE:AET) did increase its Medicaid exposure with the Coventry deal in 2012.

Optum and Amil offer interesting growth possibilities
One of the things I really like about UnitedHealth Group Inc. (NYSE:UNH) is its growth prospects outside of its historical core insurance operations. Under the Optum banner, services like disease management, specialty benefits, software/services, and pharmacy benefits management give the company some high-growth addressable markets that generally fall outside of regulated markets. True, there is competition here from sizable rivals like Cerner Corporation (NASDAQ:CERN) and Express Scripts, but UnitedHealth Group Inc. (NYSE:UNH) has been more than holding its own (and, perhaps in a bit of irony, got the general contractor role in the “tech surge” to fix the Healthcare.gov website).

Last and least is Amil, the Brazilian health insurance company that UnitedHealth Group Inc. (NYSE:UNH) acquired in 2012. Although Brazil has a universal health program, the program uses a hybrid design that allows people to buy private insurance that offers different levels of access, services, and so on than the government-sponsored system. Banco Bradesco SA (ADR) (NYSE:BBD has had more than 50% share in the Brazilian market for some time, but it has never had to compete with the likes of UnitedHealth Group Inc. (NYSE:UNH) before, and I like UnitedHealth Group Inc. (NYSE:UNH)’s odds for gaining share in this market.

The bottom line
WellPoint, Inc. (NYSE:WLP) has also tried to increase its non-premium-based businesses, but acquisitions like 1-800 Contacts haven’t been as well-received as UnitedHealth Group Inc. (NYSE:UNH)’s moves. Even so, I expect other insurance companies to follow UnitedHealth Group Inc. (NYSE:UNH) into non-regulated lines of business that can offer good combinations of growth, margins, and cash flow.

As it stands today, UnitedHealth Group Inc. (NYSE:UNH) is a so-so stock. I am very much inclined not to underestimate a company that has done so well for so long, particularly given the company’s growth potential in Medicare Advantage and non-insurance operations. An excess returns model (a model based around estimated ROE and commonly used to value banks and insurance companies) suggests UnitedHealth Group Inc. (NYSE:UNH) is fairly valued if it can limit the erosion in ROE to 15% (against a trailing 5-year average of nearly 18%). If UnitedHealth Group Inc. (NYSE:UNH) can maintain its ROE at its recent rate of 17.5%, the fair value jumps to just over $80. A discounted cash flow model likewise suggests undervaluation, as a forward free cash flow growth rate of 5% (against a trailing rate of almost 5%) results in a target in the low $80s.

I do believe there is some risk that the market is underestimating the cost and medical loss impacts of the ACA over the next couple of years. Even if that’s true, though, I think that could create some excellent buying opportunities in UnitedHealth Group Inc. (NYSE:UNH). This company is a master of pricing risk and managing expenses, and with several high-quality non-insurance businesses I like the company’s growth prospects.

 

The article UnitedHealth Ready for the Storm — and Long-Term Success originally appeared on Fool.com.

Stephen D. Simpson, CFA has no position in any stocks mentioned. The Motley Fool recommends UnitedHealth Group Inc. (NYSE:UNH) and WellPoint, Inc. (NYSE:WLP). The Motley Fool owns shares of WellPoint, Inc. (NYSE:WLP). We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.


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