Inside Wall Street: UnitedHealth is undervalued

Despite a tough economy, the managed-care industry leader continues to gain members and boost profits.

By Gene Marcial Jan 31, 2012 9:43AM
Andersen Ross/Brand X Pictures/Getty ImagesManaged-care companies aren't on Wall Street's favored list, so shares of the group remain on the ropes. Even industry leader UnitedHealth Group (UNH), which hit a 52-week high of $54 a share on Jan. 18, has been under pressure. The stock slipped to $50 on Jan. 26.


Even so, some investment pros see the stock's slippage as an opportunity to buy more shares. Some bulls see the stock, which had climbed to an all-time high of $63 in 2005, hitting $65 or more in 2012.


The long-term growth potential is robust for this diversified health care company. The group provides products and services to more than 70 million individuals through its UnitedHealthcare and Optum units. The benefits offered by the UnitedHealthcare unit include rapidly growing Medicare and Medicaid services. But the company's larger source of potential growth is driven by Optum, which provides information technology-based health care benefits to eight distinct markets, estimated to be worth $500 billion, and growing at an annual rate of 9%. So far, UnitedHealth serves only 6% of that fast-growing market. So growth potential is huge.


"The top- and bottom-line growth should be strong in 2012," says Marija Dabovic, a health care industry analyst at independent investment research firm Value Line who ranks UnitedHealth's stock as attractive in timeliness. The stock is for the "buy and hold investors," she advises, for its "wide appreciation potential through the middle of this decade." Membership enrollment "will remain robust, and the company will institute price increases where necessary," she adds.


Another big positive is the company's cash flow, which remains strong. Dabovic expects the company to continue using part of the cash flow for investments in the business, including share repurchases and dividends. She figures UnitedHealth will have a cash stash of about $5 billion after dividend payments and share buybacks.  


The company's continued leadership in the industry is pretty encouraging to the bulls. "UnitedHealth maintains a leadership position in various health benefit segments, which should lead to share gains," says Joshua R. Raskin, a health care analyst at Barclays Capital. This health service company differentiates itself through its fast-growing Optum unit, which provides a higher growth opportunity, he adds. Raskin rates the stock as "overweight" with a 12-month price target of $65.


But here's one bigger upside potential for the stock: If the health reform law "continues to prove less onerous than expected," says Raskin, and UnitedHealth continues to maintain a "positive pricing spread" and investors "recognize the premium that should accrue to its health services segment," the stock could trade at a much higher price to earnings multiple of 14.5 (from its current 11 p/e). With a higher P/E, the stock could jump to as high as $75.


An indication of UnitedHealth's continued strength was reflected in the blowout results of 2011's fourth quarter, which were well above analysts' expectations. Earnings jumped 24% from a year ago, to $1.17 a share, which was 17% above Raskin's forecast and 13.6% higher than the Street's consensus estimate. The earnings amount "was a clean number with no material one-time items," the analyst says.  


In spite of the impressive fourth-quarter results, however, UnitedHealth didn't raise its forecast for 2012. That triggered the recent drop in the stock, which closed on Jan. 30 at $51 a share. The company simply confirmed its previous revenues and earnings guidance for 2012. Management probably thought it was too early in the year to raise its expectations, Raskin says.


But to Raskin, the actual fourth-quarter results were much better in virtually every meaningful metric, including gains in membership, revenues, earnings and operating margins, and a lower medical loss ratio as cost trends improved. So Raskin is maintaining his earnings forecast for 2012 of $4.65 a share, which is within the company's forecast of $4.45 to $4.75 a share, and also retains his estimate for 2013 of $5.20 a share. But he raised his 12-month price target to $65 from $63 a share, mainly because of the increased earnings visibility.


Although the company didn't increase its earnings guidance despite the strong higher-than-expected fourth quarter results, Raskin believes the "actual run-rate earning growth is actually better than the guidance suggests."


There hasn't been a spectacular display of upside fireworks among the managed-care health care stocks, but UnitedHealth appears to be a timely play when the sector once again gains widespread attention from Wall Street and investors. Thus far, the top institutional shareholder in UnitedHealth is Wellington Management, which owns a 6.9% stake.

Gene Marcial wrote the column "Inside Wall Street" for Business Week for 28 years and now writes for MSN Money’s Top Stocks. He also wrote the book "Seven Commandments of Stock Investing," published by FT Press.

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