UnitedHealth - Jefferies Is Right, Appeal Is Limited At These Levels

Jul.11.14 | About: UnitedHealth Group (UNH)


UnitedHealth Group ¨receives¨ a downgrade from analysts at Jefferies.

Multiple expansion and inferior growth expectations are reasons to be cautious.

I totally agree with analysts: after the huge momentum in recent years, appeal is limited.

UnitedHealth Group (NYSE:UNH) received a downgrade from analysts at Jefferies, putting additional pressure on the shares on Thursday in a market which was already down.

The strong momentum in recent years and 10% run-up so far in 2014 makes analysts cautious given the inferior growth outlook and increased valuation in recent years.

Jefferies Turns Cautious

Analysts at Jefferies lowered their rating on UnitedHealth Group from buy to hold.

Earnings per share growth of 9% is below the anticipated 11% growth in earnings per share for the company's peer group. In an optimistic scenario, Jefferies sees earnings topping out at $6.20 per share for next year. This implies a growth rate of 11-12% for 2015's earnings which would be similar to its peers.

The peer-high valuation of 15 times earnings, represents quite some multiple expansion in recent times. This is despite the weaker EPS growth displayed by the company versus the peer group. This makes the current multiple as high as analysts are willing to attach to the shares given the overall multiple expansion and inferior EPS growth.

Jefferies notes that Optum is growing earnings at a projected rate of 20%, yet the contribution to overall earnings is limited as the unit makes up roughly a third of total earnings. The $6.20 EPS target for 2015 furthermore assumes continued buybacks and flat earnings growth in the United Healthcare segment next year.

Looking At The Business

For those of you covering UnitedHealth is should be well known that the company relies on Optum to grow the overall business through its health services platform. Optum serves 62 million individuals with health management and collaborative care delivery programs.

The company furthermore sees growth in its UnitedHealthcare health benefit platform. This business serves more than 4 million individuals which are underserved or don't have insurance from their employer with healthcare insurance. On top of that, the unit provides insurance to more than 26 million individuals and workers at various kinds of businesses.

The expected growth at Optum in particular and UnitedHealthcare to a lesser extent is a net positive of course going forwards. Yet the positive impact from these trends is offset by the negative impact of the Affordable Care Act. While the Act results in more customers for the company, it is impacting margins in recent years.

The impact of sequestration cuts to Medicare in recent times has impacted the company's earnings recently as the company has a large group of enrollees which rely on government financing for their healthcare.

Earlier this year CEO Stephen Hemsley expected that pressures from the Affordable Care Act and Medicare functions combined could ¨divert¨ $1.50 per share in earnings for 2014.

Valuation Of The Business

At the first-quarter earnings release, UnitedHealth issued a full-year guidance for revenues of $128-$129 billion. Earnings are anticipated to come in between $5.40 and $5.60 per share.

Trading around $82 per share, the company's equity is valued at $81 billion. This values the equity in the business at 0.6 times sales and 15 times anticipated earnings for this year.

The company recently hiked its dividend by nearly 34% to $0.375 per share on a quarterly basis, providing investors with a 1.8% dividend yield.

Past Performance

Shares of the company have performed relatively well over the past decade. Trading at highs around $60 in 2007, shares fell to lows of $20 during the recession amidst the recession and the worries about the potential impact of the Affordable Care Act.

From that moment onwards, shares have steadily gained ground, roughly quadrupling to all time highs at which the company is trading today in the $80s. Underlying these returns are the steady but impressive revenue growth rates over the past decade with the company more than tripling annual revenues between 2004 and 2013.

The strong growth in the health care sector and acquisitions like the 2004 purchase of Oxford Health Plans and the 2007 deal to acquire Sierra Health Services have fueled top-line sales growth as well.

Earnings growth has been less pronounced as margins have been under pressure. Still, earnings more than doubled to levels around $5.5 billion. Margin compression has been offset by steady share repurchases, with the company retiring nearly a quarter of total shares outstanding over this time period.

Final Takeaway

UnitedHealth's past performance has been very impressive and investors have applauded these achievements in recent years as they pushed up the share price to fresh highs.

Yet shares are not obviously cheap at 15 times earnings given the uncertainty surrounding the company's business model. Part of this uncertainty is caused by the Affordable Care Act as well as ever increasing drug prices. The very strong momentum in recent years and large size of the business makes it difficult to repeat the reported revenue growth in the coming decade. This is a reason for my caution as well.

The uncertainty in legislation and the market conditions is causing a real overhang. Combined with pressure on Obamacare, the continued modifications to the system and pressure on costs, the earnings potential is uncertain to a great extent going forwards.

On this website, a lot of talk surrounding UnitedHealth is based on the dividend of the company after a 34% hike earlier this year. Even after that increase, the current yield of 1.9% is not excessive nor very appealing in my opinion.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.