UnitedHealth Group Inc. (UNH, Financial) has joined the rather exclusive group of stocks that made it through the Buffett-Munger screener at GuruFocus.
They are what Warren Buffett (Trades, Portfolio) described as wonderful companies at fair prices. His full quote was: "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
To earn a place on that list, companies must meet four criteria:
- A high predictability rank: UnitedHealth meets that easily with a full five out of five-star rating.
- They must have a competitive advantage or a moat. UnitedHealth has what it calls "massive scale in managed care," plus important brand names.
- They incur little debt: While the company does have debt, its interest expenses are well covered by operating income.
- Must be fairly valued or undervalued based on the PEPG or PEG ratio. In this case, UnitedHealth clears the hurdle, but not by much. It has a PEG ratio of 1.41, which is above the fair value mark of 1.
What is UnitedHealth?
Based in Minnetonka, Minnesota, UnitedHealth is the biggest private health insurance company in the country, with some 50 million members. In addition, it owns Optum, which provides a multitude of non-insurance services, including medical advice and pharmaceutical benefits.
As suggested by its return on equity of 24.7%, it has competitive advantages or a moat. First, it has what it calls "massive scale in managed care." It also has well-known and respected brand names as well as inroads into international markets.
Industry-wide, medical care enjoys a tailwind. As it notes in its 10-K for 2019:
"In the United States, health care spending has grown consistently for many years and comprises 18% of gross domestic product (GDP). We expect overall spending on health care to continue to grow in the future, due to inflation, medical technology and pharmaceutical advancement, regulatory requirements, demographic trends in the population and national interest in health and well-being."
It also acknowledges it operates in highly competitive markets "across the full expanse of healthcare benefits and services." Competition is based mainly on the quality and value of its services, and is defined by elements such as product and service innovation, use of technology, consumer and provider engagement and satisfaction and sales, marketing and pricing.
GuruFocus names its main competitors as CVS Health Corp. (CVS, Financial), Cigna Corp. (CI, Financial) and Anthem Inc. (ANTM, Financial). Sorted by revenue, from largest to smallest, the companies are CVS, UnitedHealth, Cigna and Anthem.
Fundamentals
As we see orange and red on the first several lines of the table, we know debt is an issue at UnitedHealth. Still, it has a strong interest coverage ratio, so there is no threat to its short or long-term survival. This chart shows how it has grown:
The Piotroski F-Score and Altman Z-Score scores are both adequate and show a healthy company.
There is also a healthy gap between its ROIC and its WACC. Return on invested capital is more than four points higher than the weighted average cost of capital.
One more note about financial strength: As we saw, UnitedHealth gets a full five out of five-star rating for predictability. That not only means it has consistently grown its revenue per share and Ebitda per share, but is also likely to deliver above-average returns over the next 10 years, at less than average risk.
The colors on the operating margin line show us UnitedHealth's margin is in the middle of the pack among all companies in the health care plans industry; it is also doing better now than its own median over the past 10 years.
Net margin also comes in above its own history and above the industry median for the past decade. As noted, the high ROE indicates the company has a competitive advantage.
On the growth lines at the bottom of the table, we see that both Ebitda and earnings per share growth exceed revenue growth, indicating that the company is efficient.
The combined ratio is often used in assessing the profitability of insurance companies. Calculated by summing incurred losses and expenses and then dividing the result by the earned premium, it tells us how well a company is doing before factoring in investment income. UnitedHealth had a combined ratio of 82% in the third quarter of 2020.
Returns to shareholders are modest, with a dividend yield below the S&P 500 average and relatively few shares bought back.
That said, the dividend should be safe because the payout ratio is just 0.30%. And it could grow to a more respectable 3.74% if the company maintains the size of its dividend payments for the next five years, assuming investors buy today and hold for five years.
While the three-year buyback ratio is not very high, the company has successfully whittled down its shares outstanding to deliver higher earnings per share:
Valuation
Two key valuation metrics for insurance companies are price-book and ROE.
If we follow the common assumption that a price-book ratio of 1 or less shows undervaluation and a ratio of 2 or greater shows overvaluation, then UnitedHealth falls into the latter category since it has a ratio of 4.86.
Turning to ROE, the 24.7% return indicates it is a better buy than roughly half of the other companies in the health care plans industry, which have had a median ROE of 12.09% over the past decade.
The PEG (price-earnings divided by five-year Ebitda growth rate) ratio: 1.41 (higher than the fair value mark of 1, so this score would define it as modestly overvalued).
The GuruFocus Value chart comes in with a fairly valued result:
Gurus
UnitedHealth is popular with the investing gurus; at the end of the third quarter, 30 of them had positions and there has generally been more buying than selling:
These were the three largest holders at the close on Sept. 30;
- The Vanguard Health Care Fund (Trades, Portfolio) owned 9,095,277 shares, representing a 0.96% share in the company and 5.99% of its total assets under management.
- Dodge & Cox held 6,552,465 shares, after a reduction of 1.85%.
- Steve Mandel (Trades, Portfolio) of Lone Pine Capital owned 3,946,431 shares, after adding 30.5% to his stake.
Conclusion
UnitedHealth Group, as we noted at the beginning, is a Buffett-Munger stock, one that can be called a "wonderful" company and available at a "fair" price.
This analysis comes to much the same conclusion. It is financially strong (although probably more debt-laden than most value investors would like), it enjoys robust profitability and is expanding. Valuation might be classified as somewhere between fair and modestly overvalued.
Value investors might hesitate over the debt load and lack of a margin of safety. Growth investors may take an interest because of the consistent and solid increases in its fundamentals and the share price. On the other hand, income investors won't find much of interest here, at least in the short term.
Disclosure: I do not own shares in any of the companies named in this article and do expect to buy any in the next 72 hours.
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