American health care is a turbulent space these days, with the Affordable Care Act, budget restraints, aging Baby Boomers, and a whole lot more.
Yet this company seems to sail through it all reasonably comfortably, with strong revenue and earnings growth since the financial crisis of the last decade.
UnitedHealth Group Incorporated (UNH, Financial) is the biggest player in the health care field, and counts some 85-million patients on its rolls. Although it is diversifying in terms of its products, services, and geography, it is essentially an insurance play.
It has earned a place on the Buffett Munger screener at GuruFocus, because of its ability to consistently grow its bottom line, and because it is considered fairly valued, based on the combination of P/E and EBITDA growth.
By way of introduction, here’s a chart showing UNH’s share price (green line) and earnings (blue line) over the past 20 years:
History
1974: A group of physicians in Minnetonka, Minnesota get together to form Charter Med Incorporated to expand health coverage options for their patients.
1977: A reorganization sees the creation of a new company called United HealthCare Corporation. It becomes the parent of Charter Med, and new business lines are launched.
1979: Begins offering private market alternatives to Medicare; develops policies designed specifically for seniors.
1984: Starts trading publicly on the New York Stock Exchange.
1988: Enters the pharmacy benefits management business.
1997: Wins a competition to provide health coverage services to American Association of Retired People (AARP) members (which still continues).
1998: United HealthCare Corporation becomes UnitedHealth Group.
2006-2008: The company’s CEO and directors become embroiled in an options backdating scandal, with allegations they concealed more than $1 billion in stock option compensation. The incident eventually leads to settlements with shareholders and the SEC; the company avoids fines and fraud charges.
2012: Acquires majority ownership in Amil Participações S.A., Brazil’s largest health care company (covering more than 5 million Brazilians).
2012: Added to the Dow Jones Industrial Average
2013: With 85 million individuals served and 156,000 employees, it is the largest health care enterprise in the United States.
2014: For the fourth straight year, UNH ranks as number one in the insurance and managed care sector of FORTUNE magazine’s World's Most Admired Companies.
History based on information at the company website, Wikipedia, and law360.com.
Takeaways: Now, 40 years after its founding, UnitedHealth Group has become the biggest player in the biggest American industry. Not shown here are the many acquisitions it has made since inception.
UNH’s Business
In its 10-K report for 2013, UnitedHealth describes itself as, "...a diversified health and well-being company."
It goes on to say, "Through our diversified family of businesses, we leverage core competencies in advanced, enabling technology; health care data, information and intelligence; and clinical care management and coordination to help meet the demands of the health system."
The picture becomes clearer when we look at its sources of revenue in this excerpt from the 10-K:
The word ‘premium’ lets us know this is primarily an insurance company, with the lion’s share of its revenue from this one source.
It divides its operations into four reporting segments, as shown in this chart:
United Healthcare (now a division rather than the complete company) hosts the insurance business, and brings in most of the segment’s revenue. Its network includes about 820,000 physicians and health care professionals, and about 6,000 hospitals.
OptumHealth offers programs that provide ‘consumer health management and collaborative care delivery’ to individuals, employers, government agencies, and other payers.
OptumInsight: software and information products, advisory consulting services, and business process outsourcing to physicians, and organizations such as hospitals and life sciences companies.
OptumRx supplies pharmacy benefit management (PBM) services; it covers more than 30 million Americans, and processes more than one-half billion prescriptions each year.
Competition
The company describes its competitive environment as intense, and lists the following as competitors: managed health care companies, insurance companies, HMOs, TPAs and business services outsourcing companies, health care professionals that have formed networks to contract directly with employers or with CMS, specialty benefit providers, government entities, disease management companies, and various health information and consulting companies (10-K for 2013).
More specifically, its United Healthcare (insurance) operations compete with: Aetna Inc. (AET, Financial), Cigna Corporation (CI, Financial), Health Net, Inc. (HNT, Financial), Humana Inc. (HUM, Financial), Kaiser Permanente (private), WellPoint, Inc. (WLP, Financial), and numerous for-profit and not-for-profit organizations operating under licenses from the Blue Cross Blue Shield Association.
UnitedHealth Group says its competitive strength is built on:
- a national scale;
- strong local market relationships;
- the breadth of product offerings, which are responsive to many distinct market segments in health care;
- service and advanced technology;
- competitive medical and operating cost positions;
- effective clinical engagement;
- extensive expertise in distinct market segments; and
- innovation for customers
Takeaways: As we’ve seen, when you buy UNH, you’re essentially buying a health care insurance company, but is also broadening its market reach with related products and services. It’s the biggest company of its kind, and has competitive strengths that should allow it to hold its leading market position.
Growth
Here’s how UnitedHealth has grown over the past 20 years (green line share price, blue line earnings per share, red line revenue):
The company expects continued growth for itself and the industry, citing, "...inflation, medical technology and pharmaceutical advancement, regulatory requirements, demographic trends in the population and national interest in health and well-being."(10-K, 2013)
It notes that government, as a benefit sponsor, increasingly relies on private sector programs, and it expects this trend to continue.
Overall, UnitedHealth Group believes it has three core competencies that will allow it to grow:
- experience and resources in clinical care
- data and information
- empowering technology.
International operations and acquisitions may also present opportunities. The 10-K for 2013 notes that revenue increases for the year owed much to the effect of acquisitions in 2012, including Amil in Brazil.
Takeaways: UnitedHealth has a healthy history of growth, and strengths to continue growing in the foreseeable future. While it has been an active acquisitor, it hasn’t yet done much internationally, and that may offer new acquisition opportunities.
Management
Chief Executive Officer and Director: Stephen J. Hemsley, age 61, has been the CEO since 2006. Earlier he served as President and Chief Operating Officer; he joined the company in 1997.
President and Chief Financial Officer: David S. Wichmann, age 52, has been in the CFO’s office since 2011 and the President’s since 2014. He joined UNH in 1998, after serving as a partner at Arthur Anderson.
Chairman of the Board: Richard T. Burke, age 70, has been a member of the board since inception, and served as CEO of UnitedHealthcare, Inc., UNH’s predecessor corporation, until 1988. As an aside, Burke was the owner, CEO and Governor of the Phoenix Coyotes, a National Hockey League team.
Board of Directors: The board comprises CEO Hemsley and Chairman Burke, as well as eight independent directors and the founder/CEO of Amil. Areas of experience and expertise include property/casualty insurance, law, international health care, health care products, auto insurance, corporate governance, academia (health), and investment management.
Takeaways: Well-seasoned executives in the corner offices, and a well-connected board of directors should enable the company to execute on its growth plans.
Ownership
Gurus: The star investors followed by GuruFocus hold UNH in a big way: 28 gurus have shares and eight of them each hold more than a million shares. The biggest three are:
- Vanguard Health Care Fund (Trades, Portfolio): 20,519,100
- Dodge & Cox: 16,907,750
- Chris Davis (Trades, Portfolio): 13,273,506
Warren Buffett (Trades, Portfolio) had held UNH and WellPoint before 2010, but exited both companies as momentum picked up on legislated health care reform.
Institutional Owners: We see a couple of major institutional owners above; as the following chart from nasdaq.com shows, nearly 90% of the outstanding shares belong to institutionals, including pension funds and mutual funds:
Shorts: About 1.9% of the interest in UnitedHealth is a short interest, which is in the low end of the range established over the past five years:
Insiders: GuruFocus puts insiders at 1%; among the insiders, Yahoo! Finance reports CEO Hemsley has the largest position, 2,777,964 shares (as of September 23, 2014), while Chairman and former CEO Burke owns 2,283,973 shares (October 20, 2014).
Takeaways: Strong interest among institutional investors and the two most senior executives, with light interest from shorts. Consensus suggests this company is not likely to slip back; at the same time, the high institutional interest means we’re not likely to see any sharp moves up or down.
UnitedHealth Group by the Numbers
Takeaways: The company has a large number of outstanding shares at almost 1 billion; it is near its 52-week high; return on equity comes in a 16.5%; it pays a modest dividend; and it has been buying back shares.
Financial Strength
The GuruFocus system gives UNH good, but not outstanding scores for Financial Strength and Profitability & Growth:
Looking more closely at this chart, we see that while it is strong compared to its peers, its current status compares unfavorably with its past status. Let’s look at the specifics:
Cash to Debt: This refers to the ability of a company to pay off its debt with cash and equivalents; the following chart indicates why we see the red icon above (cash is the green line, long-term debt is the blue line):
However, the following chart helps us put the debt situation into context (total current assets is the green line, long-term debt is the blue line):
Equity to Asset: This refers to the relationship between the amount of equity (shareholder contributions) and the amount of assets generated by that equity. The following chart shows why we see a red icon:
At the same time, though, let’s have a look at the flip side, a chart showing Return on Equity (ROE):
While the Equity to Asset ratio looks negative, the Return on Equity has been relatively consistent for a number of years.
Interest Coverage: Refers to the ability of a company to pay its interest expenses out of operating income. For UNH, that ratio currently sits at 13.59, which allows lots of room for interest payments. So why the warning icon? Likely because it was above 16 for fiscal 2010 and fiscal 2011 and above 14 for fiscal 2012, before falling to its current level in fiscal 2013.
Net margin: Again, we see slight slippage in fiscal 2013, to 4.59%; for fiscal 2011 the company registered a net margin of 5.05%, after recovering from a low of 3.67% in 2009.
Revenue: Another warning icon; however, as the following chart shows, revenue has continued to rise:
Free cash flow: Finally, let’s take a look at the FCF, which has dipped a bit lately, but generally continues its upward trend:
Takeaways: The GuruFocus system generates several automated warning icons. However, closer investigation reveals what appear to be normal fluctuations, so we come away confident the company is financially sound.
Valuation
We’re examining UnitedHealth because it appeared in the Buffett Munger screener, which means we can expect predictable, or at least reasonably predictable, earnings and a rating of undervalued or fair valued.
Looking first at its predictability, UNH receives a 4.5 out 5 rating for predictability, which is very good. To get this kind of score, a company must consistently generate growing earnings and, in turn, we can expect the valuation/share price to follow the earnings lead.
Consistent growth also lessens the risk of the stock price dropping back significantly. We still expect modest ups and downs as the bulls and bears push the price back and forth, and the stock price is still susceptible to market-wide plunges. A high predictability company is a quality company, and we would expect it to hold up better than most of the market in a serious selloff.
Turning to the actual valuation metric, the Buffett Munger screener divides the P/E ratio by the average 5-year EBITDA growth rate to produce PEPG or PEG (as first devised by Peter Lynch). This measure helps us deal with the sector (and other) variability that makes the P/E ratio undependable if used across different industries. What PEG gives us is an industry- or sector-neutral valuation.
At the close of trading on December 10, 2014, UNH had a PEG ratio of 1.26 which puts it in the category of fairly valued stocks. A rating below 1.0 is considered undervalued, a rating between 1.0 and 2.0 is considered fairly valued, and anything over 2.0 is considered over valued. Thus, we can say, more specifically, UNH is in the low end of the fairly valued category.
UnitedHealth pays a forward annual dividend of $1.50 ($1.40 trailing), which equates to a yield of 1.5%, with a payout ratio of 24%. And, given the company’s dividend per share growth in recent years, patient investors could be rewarded handsomely:
It’s also been buying back shares. During calendar 2013 it bought back 48 million shares, representing a buyback ratio of 3.04, according to its 10-K Report.
Takeaways: Positive results on the key measures of predictability and valuation; in addition, it has a growing dividend and share buybacks.
Opportunities & Risks
While the Affordable Care Act raised concern for companies like UnitedHealth, it has turned out to generate new opportunities, as a new group of potential customers emerges.
Health care is intensely regulated, which makes operations more complex and costly, but it might also be argued that knowing, understanding, and being able to manage the regulations provides a moat (a barrier to entry by other companies).
The American population is aging, as Baby Boomers grow older, driving up the need for both medical care and insurance to cover the cost of that care.
In 2012, UNH expanded into the international arena with its purchase of Amil; undoubtedly, other opportunities exist and will develop as countries such as Brazil grow larger middle class populations.
As it grows beyond its insurance base, the company will develop not only new products and services, but also synergies that have not previously existed.
Risks
As an insurance company, it has to predict the cost of future health care services, something that’s difficult to do in an industry that’s in flux. According to its 10-K for 2013, about 90% of its consolidated revenue comes from health care premiums, and of that some 80% to 85% of that is needed to pay medical costs.
In addition, reams of new legislation at the state and federal levels could derail the strategy that’s allowed it to grow successfully. Currently, the company is quite concerned with the effect Health Reform Legislation could have on pricing.
Because it participates in government health care programs, both as a payer and as a service provider to payers, UnitedHealth faces a range of risks. That includes everything from delays in payments to extensive audits.
Health care has a high profile in public affairs, and potential always exists for hits to its reputation. This in turn could affect its ability to grow the business, collect from government, and develop partnerships with other companies and providers.
As a health care company, it holds a great deal of sensitive patient data, and any security breaches could cause it financial and reputational harm.
Outlook
There’s no doubt it’s difficult to compete in the health care industry, yet UnitedHealth has done so in the past, as we have seen in charts of its revenue and earnings.
Along with this history, it has a well-seasoned management team that should be able to guide the company forward confidently.
Overall, then, UNH appears well positioned to continue generating strong returns for its investors.
Conclusion
UnitedHealth Group earns a place on the Buffett Munger list thanks to its ability to consistently generate revenue and earnings, as well as its fairly valued status.
The company pays a modest dividend, but has aggressively increased it over the past four years. With a payout of just 24%, the dividend should be safe and there’s room for the company to increase it in the future.
We also note the company also has bought back shares, which should help it maintain its pace of earnings growth.
Altogether then, UNH deserves the attention of investors looking for both income and capital appreciation.
　
