Digest Summary
Investors in United Health Group, Inc. (“UNH” or the “Company”) should make an investment decision based on their assessment of the following issues:
Investment Merits
Consistent Results / UNH is the industry leader in terms of consistently meeting performance targets; EPS have exceeded expectations for at least the past 6 quarters and have grown rapidly for the past five years. Additionally, the Company maintains one of the highest operating and net profit margins in the health and managed care industry.Management Effectiveness Strength / UNH has one of the some of the highest returns in the managed care industry as well (refer to the Valuation section for further details). High levels of returns combined with robust and consistent historical results lead many to conclude that UNH deserves a premium valuation as compared to its peer group
Market Leading Positions / For reasons stated above, UNH is one of the most disciplined managed care operators. It also maintains one of the lowest levels of indebtedness that enable it to pursue aggressive share buybacks and strategic acquisitions, such as the just closed acquisition of Mid-Atlantic Medical for just under $3 billion.
Investment Drawbacks
Acquisition Signaling? / Bearish analysts are concerned that recent merger activity in the industry is a sign that Company’s expect the favorable operating environment of the past few years to become more difficult. An increased M&A landscape could signal that organic growth will be harder to come by and that cost reduction through acquisitions may be pursued.Premium Valuation? / Those with a neutral bias on the shares believe that a premium valuation is not warranted for UNH. This stems largely from skepticism on the ability to meet future results, , and that overall competitiveness will increase.
Overview
Analysts have identified the important UNH factors as maintaining its spread between medical revenue and costs, and proper reserving for medical claims. Analysts are almost unanimous that UNH is performing well in both areas. The metric used to monitor UNH’s spread between medical revenue and costs is its medical loss ratio (MLR) or medical cost ratio (MCR). The MLR and the MCR are the same metric.
UnitedHealth Group Inc. offers health care coverage and related services to help people achieve improved health and well-being through all stages of life. The company's products and services reflect a number of core capabilities, including medical information management, health benefit administration, care coordination, risk assessment and pricing, health benefit design and provider contracting. With these capabilities, it is able to provide comprehensive health care management services through organized health systems and insurance products. UNH had total revenue of $28.8 billion and EPS of $2.95 for its fiscal year ended December 31, 2003.
UNH recently reported Q4 and final year ’03 results which were above expectations for at least the sixth straight quarter. Additionally, the Company announced in late October the intent to acquire Mid-Atlantic Medical (MME) for just under $3 billion; the acquisition closed late last week. While not a huge acquisition for UNH, it is significant and is detailed further in the individual analyst comments below.
The Company has provided the below FY ’04 guidance:
EPS $3.70-$3.73
EPS Growth 25%-26%
Revenue $35-$36 billion
MLR 80.0% +/- 50 basis points
EBIT $3.7 billion
EBIT Margin 10.5%
CFO $3.6 billion
CapEx $400 million
FY ’05 guidance calls for 15% EPS growth.
Sales
Total UNH revenue was $25.0 billion in 2002. Its revenue has grown at an annual rate of 29% over the past 9 years, at just over 10% for the past 5 years, and 10.9% over the past 3 years. FY ’03 revenue came in at $28.8 billion, slightly above the $28.7 expected and representing a 15.2% growth rate. The average sales estimate for FY ’04 is $34.9 billion; this represents 21.0% growth. Sales estimates for analysts with published updated income statements are included in the accompanying spreadsheet.
UNH derives its revenue from five operating companies: UnitedHealthcare, Ovations, Uniprise, Specialized Care Services, and Ingenix. United Healthcare offers health benefit plans to individuals, small and mid-sized businesses. It also offers health benefits to the beneficiaries of Medicaid through its AmeriChoice program. Ovations focuses on providing health and well-being services to people over age 50 while Uniprise provides health benefit solutions to the country’s largest employers. Specialized Care Services offers benefit plans in varied fields, such as dental, vision, and nursing among others. Ingenix provides health and pharmaceutical information and intelligence to physicians and other health care professionals.
Margin
UNH’s relevant margins are the Medical Loss Ratio and operating margin. MLR is relevant because it captures the company’s ability to price its services and negotiate the costs of medical care. The pre-tax margin is relevant because it captures the company’s ability to reduce its SG&A expenses and its ability to earn investment income, an important revenue source for a managed care company.
UnitedHealth’s MLR was 85.3% in 2001 and 83.0% in 2002. This number has decreased to about 80.3% in the most recent quarter and year-end period (analyst calculations vary slightly but remain around 80-81%). This is predicated on its current pricing and cost trends which show very slight deterioration on both pricing and costs. However, analysts estimate this trend will stabilize itself over the next few years as it is not expected to remain as low as 80%; estimates range from 80-81% and the short-term with a projected increase to 82-83%.
The Company’s operating margin stood at 8.7% for FY ’02 and came in at 10.2% for FY ’03. It is expected to increase to 10.6% for FY ’04. This improvement is expected to be driven by a favorable pricing environment and the foreseen ability to further drive economies of scale to maintain a favorable MLR, drive up gross margin and decrease SG&A expense.
Earnings Per Share
EPS have grown at an 39.3% annual rate over the past three years and at just over 38.7% for the past five years. EPS for FY ’03 came in at $2.96; growth for FY ’03 vs. FY ’02 was an impressive 39.0%. FY ’04 growth vs. FY ’03 calls for a 25.7% increase. This rate of growth is lower than historical rates and is expected to decrease slightly more as analysts are projecting long-term EPS growth of just under 19% per year.
Actual EPS results have exceeded consensus estimates for at least the past six quarters. The consistent results speak to the visibility and steadiness of Management’s business model. The consistent growth rate in EPS also speaks to Management’s discipline in maintaining predictable results, a difficult feat in any industry.
Consensus and actual results for the past six quarters are detailed below:
Quarter Period Ending / Consensus EPS Est. / Actual Reported EPS / Over/(Under)Q4 ‘03 / 0.79 / 0.83 / 0.04
Q3 ‘03 / 0.74 / 0.77 / 0.03
Q2 ‘03 / 0.66 / 0.71 / 0.05
Q1 ‘03 / 0.62 / 0.65 / 0.03
Q4 ‘02 / 0.58 / 0.60 / 0.02
Q3 ‘02 / 0.52 / 0.56 / 0.04
Target Price/Valuation
Bullish analysts believe that UNH deserves a premium valuation in comparison to its peers and the fact that growth prospects continue to be very robust. Though not surprising in sell-side research, it is worth noting that 89% of analysts covering the Company are positively biased on the stock. The remaining 11% are neutrally stanced.
The average price target for the analysts providing such a number is $68.60. This represents 15.0% upside from the current stock price. The highest price target represents 34.1% upside while the lowest price target represents 5.6% upside from the current stock price. Clearly, even neutrally stanced analysts expect significant upside from where the stock is currently trading. Refer to the accompanying spreadsheet for individual analyst details.
UNH, at $59.67, trades at 21.2x FY ’03 EPS. Price to free cash flow is within the P/E range at just under 14x for the past trailing twelve months (ttm). Based on consensus FY ’04, the forward P/E is 16x. Taking into consideration long-term expected growth in EPS, the Company’s forward P/E to long-term growth ratio (PEG) is 0.86. A PEG under 1 is generally considered favorable. However, the individual must determine his/her conviction in the expected long-term growth rate. UNH could support a higher PEG ratio due to the consistency of its results over the past five years and the robustness of expected long-term results.
Additionally, Price to Sales (P/S) stands at 1.3x (ttm). This is slightly higher than the average 1.0x for the Accident and Health Insurance Industry but below the average 3.57x for the S&P500.
Metrics detailing Management Effectiveness are as follows:
Metric / ValueReturn on Assets (ROA) (ttm) / 12.01%
Return on Equity (ROE) (ttm) / 38.96%
Return on Invested Capital (ROIC) (ttm) / 26.67%
Return on equity is extremely high. ROIC is lower but also very favorable as it is almost 3x the 10% average for the S&P500. UNH is a uniquely profitable company that has performed at a high level for quite some time.
Debt as a percentage of total capital stood at 25% as of 12/31/03. This is a relatively low level of indebtedness in absolute terms as well as compared to other managed care companies; a level below 40-50% is generally seen as favorable while a ratio of 60% or greater should be cause for concern. Low levels of debt allow UNH flexibility in the decisions to make acquisitions, payoff debt, reinvest in existing businesses, etc.
Long-Term Growth
Twelve analysts have published a 3-5 year EPS growth rate. The average long-term growth rate is 18.6%. Management has targeted a long-term EPS growth rate of 20%, therefore analysts as a whole are slightly less optimistic than management.
The areas in which UNH needs to perform in order to achieve its long-term growth objectives are: (1) maintaining its MLR, which implies keeping its medical care revenue and costs in check and growing in tandem; (2) continued overall membership growth which ensures market share growth follows; (3) continual improvements of technology which reduce G&A expenses; (4) an aggressive share buyback program.
Analysts see the company maintaining its pricing growth in the low single-digits annually, and annual medical cost growth in the 10-11% annual range which is down from 11-12% guidance previously. Analysts expect UNH management to continue share repurchases due to significant amounts of free cash flow and low levels of indebtedness.
Individual Analyst Opinions
The below highlights relevant information from the most recent reports on UNH from the analysts currently covering the Company. Please refer to the accompanying spreadsheet for specifics on individual income statement projections (including sales and EPS), recent revisions to estimates, and justifications for price targets provided.
POSITIVE RATINGS
Advest – Buy ($68): According to Advest:
Fourth quarter EPS of $0.83 came in ahead of the firm’s estimate by $0.04. The key variation vs.
Its model was administrative, with SG&A as a percentage of revenues declining sequentially to an all-time low level. Its 2004 EPS estimate of $3.76 is slightly above management's guidance. With a revised $68 price target, its rating remains Buy. The firm values United shares on a P/E basis, using a 15x target multiple of forward at-risk income and a 20x target multiple of forward non-risk income. Applying this target to its forward EPS estimate of $3.76 yields a valuation of $68. Principal risks are integration of the MAMSI and Golden Rule acquisitions; the potential impact of the economy on premiums, enrollment, and medical costs; and the ongoing challenge of medical cost containment.
Banc of America - Buy ($64): According to Banc of America:
UNH’s Q4 EPS $0.83 was $0.05 ahead of expectations on lower medical costs and $0.02 of favorable prior period development related to 2002. UNH also reported $70 million in favorable development related to earlier quarters in 2003, but this has no impact on full year results. The quarter was strong, but the analyst is focused mostly on 2004 enrollment, and Uniprise added 500,000 lives on January 1, keeping it on target for a gain of 600,000-700,000 lives for the full year. Commercial risk enrollment grew
395,000 lives, but Golden Rule may account for more than 400,000 of these lives. The Company raised its 2004 EPS guidance from $3.65 to a range of $3.70-3.73. The firm raised its 2004 estimate from $3.60 to $3.70, and introduced a 2005 estimate of $4.25. The analyst expects UNH’s Medicare rates to increase nearly 10% in 2004. Valuation and Target Price Analysis: The firm’s $64 price target implies UNH can trade at 15.1x its 2005 EPS estimate.
Bear Stearns – Outperform ($67): According to Bear Stearns:
UNH reported Q4 EPS $0.83 per share, up 38% and $0.04 above the firm’s estimate. Versus its estimate, $0.03 of upside on better underwriting margins and $0.01 on investment income. Reserve developments remain consistent and relatively modest. Excluding impact of Golden Rule, total medical membership would have shown slight sequential decline, as employment related attrition continued to impact Uniprise business. The analyst believes this factor, and competitive markets, could continue to moderate 2004 bookings, as a result are reducing our enrollment outlook. Medical cost moderates again. The firm believes that the Company continues to price at or slightly better than current cost trend levels, a factor that would be additive to its earnings outlook given the firm’s view that medical cost trend will likely decelerate in ’04. Operating cash flow was stronger than expected, at $870 million (1.7x net), for the quarter and $3.0 billion for full year 2003 compared to prior full year outlook of $2.7 billion. The analyst raised his 2004 EPS by $0.11 to $3.75 and 2005 by $0.15 to $4.35 and also edged up the price target.
CIBC – Sector Outperformer ($72): According to CIBC:
UNH reported Q403 EPS of $0.83, better than the firm’s $0.79 estimate. Upside was attributable to a lower than expect medical loss ratio (MLR) and SG&A ratio. Revenue of $7.5 billion was above the analyst’s $7.2 billion estimate, in part due to the Golden Rule acquisition that closed in Q4. Membership growth was essentially flat excluding the Golden Rule transaction. Little sequential growth was expected in Q4. Guidance for 2004 membership growth (+600,000 in Uniprise and +500,000 in Healthcare Services) was consistent with guidance issued in November. UNH expects the medical cost trend in 2004 to range from 9.5% to 10%, down from the 10%-11% projection made at Q303. Pricing is expected to range from 9.5% and 11%. According the firm, positive comments made by the company on UNH should help relieve investor concern surrounding 2004 margins. On the strength of the quarter, the analyst raised his 2004 and 2005 EPS estimates to $3.75 and $4.40, respectively. His estimates are slightly ahead of management guidance. He also raise the price target to $72 (from $60).