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UnitedHealth Group Inc. (UNH) starts off the earnings season for managed care companies with its 3Q 2011 earnings on October 18, 2011. The Zacks Consensus estimate for the quarter stands at $1.12 which translates into an earnings growth of 12.12% year over year.

We believe UnitedHealth's earnings report will disclose improving performance from its health benefits and rapidly growing health services businesses. Lower medical utilization is also expected to be a major tailwind for earnings.

Previous Quarter Performance

UnitedHealth’s second quarter earnings came in at $1.16 per share, substantially ahead of the Zacks Consensus Estimate of 93 cents. The results also soared from 99 cents in the prior-year quarter.

The strong results were primarily supported by strong revenue growth from UnitedHealthcare, as well as from its Optum businesses which gained from enrollment and low medical utilization. Share repurchases leading to a lower weighted average diluted share count also augmented operating results.

UnitedHealth reported revenue of $25.23 billion in the quarter, up 8.5% year over year.

Earnings Estimate Revisions: Overview

Prior to the results release, earnings estimates inched up marginally to $1.12 per share from $1.11 over the last 7 days. The increase however, marginally indicates strength in the stock.

We provide below the details of earnings estimate revisions to substantiate investor optimism in the stock.

Agreement of Estimate Revisions

A handful of analysts, only four out of 19 covering the stock, have pulled up their estimates for the third quarter over the last 7 days and also for the past 30 days, it is quite clear that analysts are in agreement with the bullish third-quarter earnings outlook for UnitedHealth, given the absence of any downwards estimate earnings revision.

Moreover, for FY11 and FY12, five and two of the total 21 analysts for both the periods, respectively, have raised their estimates over the last 7 days and also over the past 30 days.

The upward revisions prove that the analysts are in agreement with the company’s above-the-line earnings expectations. Analysts expect the company to beat the estimates on the back of rational pricing, moderating flu trends, adequate reserves along with an increase in enrollment.

Magnitude of Estimate Revisions

The Zacks Consensus Estimate for the third quarter inched up modestly to operating earnings of $1.12 per share from $1.11 over the last 7 as well as last 30 days. Also, estimates for FY11 edged upward from earnings per share of $4.35 to $4.37. For FY12, estimates went up to $4.79 from $4.78 per share to $4.61.

Though the magnitude of estimate revisions was very small, the absence of any negative estimates indicates the analysts’ optimism in the stock.

Earnings Surprise

UnitedHealth has been throwing positive earnings surprises over the trailing four quarters with the average earnings surprise of positive 26.70%. This implies that the company has beaten the Zacks Consensus Estimate by the same magnitude over the last four quarters.

Our Take

We are upgrading our recommendation for UnitedHealth to Outperform from Neutral just before the release of the third quarter earnings as we believe that the company would beat the Zacks Consensus estimate as Medicare and Commercial costs continue to remain at historical lows amid the sluggish economy.

UnitedHealth Group is one of the most diversified of the listed managed care companies. With a broad product and service offering, the company targets the entire population.

As a result, earnings are buffered to a certain degree against any single unfavorable change in market dynamics at the divisional level. This is evidenced by the growth in the company’s revenues for the past five years. Though the market remains challenging, we expect the company to grow revenues, albeit at a slower rate.

With impressive operating cash flows, aggressive share repurchase, low leverage, UnitedHealth is a long-term value stock for investors.

UnitedHealth is well positioned among its peer group as it has the ability to diversify its earnings stream. Given its diversity and soundness of operations, the company is well positioned to handle the challenges of the health care reform.

Currently UnitedHealth carries a Zacks #1 Rank, which translates into a short-term ‘Buy’ recommendation.

Peers are to report earnings as follows: WellPoint Inc. (WLP) is expected to report third-quarter results on October 26 and Aetna Inc. (AET) the following day. Humana Inc. (HUM) reports its earnings October 31, and Cigna Corp. (CI) announces results on November 3.

Source: UnitedHealth Group Earnings Preview