Companies specializing in the sale and administration of healthcare plans have performed well through the last 12 months. Shareholders have seen some great returns as the need to cover emergency medical needs has increased, and Medicare and Medicaid programs have grown.
However, with the government having to tackle its budgetary debts further increases in such programs may be under threat. Here we look at the relative share valuations of two companies in this sector, comparing their recent share price performance, and suggesting the time is right to execute a pairs trade: Buy WellPoint Inc (WLP) vs sell UnitedHealth Group (UNH).
WellPoint Inc (WLP)
Shares are currently trading around $68, in the middle of their 52-week price range of $54.10 to $81.92.
Earnings per share for the last 12 months are $7.55, and these are expected to reach $7.72 in its next fiscal year (ending Dec 2012). These numbers place the shares on a trailing price to earnings ratio of 9.05 and a forward multiple of 8.85.
WLP paid a dividend of $1.00 last year, which was covered 7.5 times by its earnings. At the current market price, the payment of this level of dividend offers investors a yield of 1.50%. Current operating margin at WLP is 8.02%, and revenue per share as stated in its last income statement was $155.46. Revenues grew by 4.60% last quarter compared with the same period last year.
WLP holds cash of $19.56 billion, and has debts totaling $9.66 billion. Its debt to equity ratio is 39.95. Servicing its operations and debt, its operating cash flow through the last 12 months has been $3.37 billion. The reported book value of the stock is $66.76 per share, placing the shares on a premium to book value of 1.86%.
Analysts median price target for the stock is $86, implying an upside from the current market price of 25%.
WLP Shares have out-performed the S&P 500 Index through the last 12 months, though the price fell more heavily than the market when equity prices collapsed in August. Prior to this, shareholders had been sitting on a share price rise of over 40% from October last year. This paper profit has been cut to a mere 18% now.
The company has extended its share repurchase program by $5 billion, and it will use this authorization over the coming years as it sees market and industry conditions offering value by doing so. In the first half of this year, it repurchased 20.8 million shares at a cost of $1.5 billion. Shareholders criticized the company for doing this rather than paying a dividend. The company responded by announcing quarterly dividends of $0.25 per share.
WLP announced on October 6 that it has been awarded a major Medicaid contract worth an estimated $273 million, to which shares have reacted positively and since increased by around 8%.
UnitedHealth Group Inc (UNH)
Shares are currently trading around $49.00, in the upper quartile of their 52-week price range of $34.50 to $53.50.
Earnings per share for the last 12 months were $4.51, and these are expected to reach $4.76 in its next fiscal year (ending Dec 2012). These numbers place the shares on a trailing price to earnings ratio of 10.88, and a forward multiple of 10.29.
UNH paid a dividend of $0.65 last year, which was covered 7 times by its earnings. At the current market price, the payment of this level of dividend offers investors a yield of 1.40%. Current operating margin at WLP is 8.37%, and revenue per share as stated in its last income statement was $92.23. Revenues grew by 6.80% last quarter compared with the same period last year.
UNH holds cash of $16.38 billion, and has debts totaling $11.92 billion. Its debt to equity ratio is 42.76. Servicing its operations and debt, its operating cash flow through the last 12 months has been $8.82 billion. The reported book value of the stock is $25.74 per share, placing the shares on a premium to book value of 91%.
Analysts' median price target for the stock is $58.85, implying an upside from the current market price of 20%.
UNH shares have traded very positively over the last 12 months, and shareholders have been rewarded with a capital return of over 30% in this time. As with the broader market shares fell back in August, though did not suffer as much as WLP shares.
Recent news has been mixed at UNH, though the shares continue to push ahead.
Avalere, a consulting firm based in Washington, said that a study has shown UNH may lose 500,000 enrollees from its Medicare drug plans next year, as premium increases price it out of the market.
On October 18, CEO Stephen Hemsley told analysts that he expected earnings to grow next year, though high unemployment rates, growing care use and the healthcare overhaul would pressure performance. He is said to have cited "a laundry list" of negatives without any equal positives. Though having fallen on the day of this announcement, the shares have since recovered by 8% and stand higher than before the announcement.
Basis For Investment
Looking at the 12-month chart, it is clear that UNH shares have out-performed WLP shares since August. On the basis of share price trading patterns, news flow from the two companies, and company fundamentals, I think that this gap in performance has stretched too far, and will reverse over the coming weeks/months.
I see no justification for WLP shares trading on a lower forward price to earnings ratio than that of UNH. Operating margins are of equivalent strength, as is the debt to equity ratio of the two companies. WLP has recently won a large Medicare contract, while UNH has warned that the healthcare review will harm its results. UNH has also stressed that other factors will likely pressure its results gong forward.
WLP has introduced a dividend, having listened to the concern of shareholders, which will attract dividend investors. I see its share repurchase program as offering support to the share price, and added value to shareholders.
From analysts forecasts, the implied upside of WLP shares from their current level is 25%, while that of UNH is 20%. WLP shares also trade on a far lower premium to reported book value than UNH.
For all these reasons, I think the time is right to place a pair trade between the two stocks and recommend buying WLP and selling UNH.