Major headwinds from healthcare reform have presented the opportunity for higher risk-adjusted returns in an industry with inelastic demand. More than a month ago, I argued here that UnitedHealth Group (UNH) was a "strong buy," despite risks. Since the article was published, the stock has appreciated by 6.1% and outperformed the competition. During the same time period, Cigna fell by 3.6% and the S&P 500 fell by 1.6%. While UnitedHealth Group has closed much of its discount to intrinsic value, it still has upward potential. I find that it is less undervalued than WellPoint (WLP), but more undervalued than Cigna (CI).
From a multiples perspective, Cigna is the cheapest of the three. It trades at a respective 7.7x and 7.5x past and forward earnings. WellPoint and UnitedHealth Group trade at a respective 8.6x and 11.1x past earnings. With that said, Cigna offers barely any dividend yield relative to the competition.
At the third quarter earnings call, Cigna's CEO, David Cordani, noted solid results:
The headline is we delivered another strong quarter from our ongoing businesses. Our operating results demonstrated top line and bottom line growth as a result of effectively executing on our strategy and delivering on our fundamentals of pricing discipline, and clinical and service excellence.
In our third quarter of 2011, we reported consolidated adjusted income of $370 million or $1.36 per share, excluding the effect of VADBe, with consolidated revenue growth of 6.5% reflecting positive contributions from each of our ongoing businesses. As we all know, 2011 continues to be a dynamic year in the global economy. From a health care perspective, the aging populations, declining health status, unsustainable health care economics and the evolution to consumerism are all catalysts for change.
In regards to legislative reform, Cigna is not staying still, but rather taking actions to keep up with healthcare evolution. The firm takes a consultatitive approach to build client loyalty - the Select segment has grown its customer base by 14% in the third quarter.
In regards to the HealthSpring acquisition, Cigna now has more opportunities than ever in Medicare. This transaction will unlock revenue synergies, since Cigna could shift its business mix from Commercial to higher-margin at-risk Medicare products. In Commercial, the healthcare company is also well positioned to add 400,000 members in 2012. In International, the firm is successfully penetrating the market and further raising upside.
Consensus estimates for Cigna's EPS are that it will grow by 13.1% to $5.27 and then by 7% and 12.2% more in the following two years. Assuming a multiple of 9x and a conservative 2012 EPS of $5.56, the rough intrinsic value of the stock is $50.04, implying 18.6%. This is not enough, in my view, to consider calling the investment a value play.
By contrast, earnings potential for WellPoint has not yet properly appreciated by the market. Consensus estimates for the firm's EPS are that it will grow by 5.2% to $7.09 in 2011 and then by 9.3% and 11.9% more in the following two years. Assuming a multiple of 11x and a conservative 2012 EPS of $7.69, the rough intrinsic value of the stock is $84.59, implying 28.8% upside. Perhaps this is the main reason why WellPoint is rated closer to a "strong buy" than Cigna is.
UnitedHealth Group is arguably the safest of the three. It had solid third quarter results with top-line growth of 7% and excellent liquidity. Although higher utilization trends and rebate obligations are eating into margins, Optum and acquisitions more than offset as catalyst. In the third quarter, Optum had double-digit growth.
2012 health-benefit revenues should range from $99.5 - $100.5B, an improvement of $4.8B. The impact of risk-based membership declines of 200,000 will be more than offset by fee-based enrollment additions of 500,000 (both figures are high-end estimates). In addition, Medicaid is helping to drive Public membership growth of potentially 745,000 additions.
Consensus estimates for UnitedHealth Group's EPS are that it will grow by 8.6% to $4.57 and then by 4.4% and 13.8% more in the following two years. Of the 8 revisions to estimates, all have gone up for a net change of 0.9%. Assuming a multiple of 11.1x and a conservative 2012 EPS of $4.41, the rough intrinsic value of the stock is $61.62, implying 23.3% upside. Even if the multiple were to hold steady at 11.1x and 2012 EPS turns out to be 6.4% below the consensus, the stock would fall by only 2.1%. Analysts currently rate the company around a "strong buy."