Some of the most attractive defensive plays can be found in the healthcare sector where demand is inelastic and revenue streams are sustainable. The Street is currently bullish about Aetna (AET), UnitedHealth Group (UNH), and WellPoint (WLP), rating them either a "buy" or higher. Based on my review of the fundamentals and multiples, I find that Aetna will outperform United - despite a contrary consensus.
From a multiples perspective, Aetna is substantially cheaper than United. It trades at a respective 8.7x and 8x past and forward earnings while United trades at a respective 11x and 9.6x past and forward earnings. Aetna's PE multiple is also 80% of the 5-year average, indicating a comfortable room for expansion. In terms of free cash flow yield, WellPoint leads by this metric at 11.1%.
At the fourth-quarter earnings call, United's CEO, Stephen Hemsley, noted a successful year:
2011 was a strong year across a wide range of performance factors. Continued focus on fundamental execution improved service and value for our customers. Financial performance was driven by revenue growth across all of our businesses, including from new business relationships and strong retention of our established clients. Relentless cost management and continued business simplification were prevailing themes in 2011, and innovation and development activities for new markets advanced steadily throughout the year, as we strengthened key capabilities to respond to emerging growth opportunities.
While the company has had strong growth in Medicaid and Medicare Advantage enrollment, it is also well positioned to gain from consumer-directed health plans as a results of strategic investments. Management has demonstrated strong control over its cost base and the company has a healthy balance sheet that allows for takeover activity that will diversify the business. Even still, state budget cuts substantially reduce visibility in the near-term outlook for Medicaid. Accordingly, even though the company beat recent consensus by 14%, management still issued conservative guidance. Margins and ROE are further trending downward as net debt increases over the next two years.
Consensus estimates for United's EPS forecast that it will grow by 1.3% to $4.79 in 2012 and then by 12.9% and 10.7% in the following two years. Assuming a multiple of 12.5x and a conservative 2013 EPS of $5.38, the rough intrinsic value of the stock is $67.25, implying 29% upside.
Aetna produced recent quarterly results that were roughly in-line with expectations. Medical membership gained by 230K to 18.46M, but 28.3% of this growth was not organic but rather driven by the acquisition of Genworth's Medicare supplement. Management remains optimistic about Medicare enrollment in 2012. Low utilization is holding still and benefitting Commericail MLR in the meanwhile. At the same time, SG&A is being meaningfully constrained to help offset the impact of higher taxes.
Consensus estimates for Aetna's EPS forecast that it will decline by 0.8% to $5.13 in 2012, and then grow by 9.7% and 11.9% in the following two years. Assuming a multiple of 11x and a conservative 2013 EPS of $5.55, the rough intrinsic value of the stock is $61.05, implying 35.2% upside.