According to T1 Banker, the Street is bullish about Aetna (AET) and UnitedHealth Group (UNH). I find that both companies are attractive plays, and recommend opening long positions. Based on my review of the fundamentals and multiples, however, I differ from the Street in my greater preference for Aetna.
From a multiples perspective, Aetna is the cheaper of the two. It trades at a respective 9x and 8.3x past and forward earnings, with a dividend yield of 1.5%. United, on the other hand, trades at a respective 11.8x and 10.2x past and forward earnings, with a dividend yield of 1.2%. To put this in perspective, consider that Aetna is valued at only 84% of its historical 5-year average PE multiple.
At its fourth-quarter earnings call, Aetna's management noted a strong close to 2011.
"This morning, we reported fourth quarter operating earnings per share of $0.97, a 54% increase over 2010. This excellent operating performance caps off a strong year for the company, our customers and our shareholders. For the full year 2011, Aetna reported operating earnings of $5.17 per share, a 40% increase over 2010…
Favorable Commercial underwriting margin was the result of low medical utilization but also Aetna's continued pricing discipline, medical cost management and unit cost control, resulting in a full year 2011 commercial medical benefit ratio of 77.9%. Despite the pressure on reimbursement rates, our Medicare business posted another strong quarter and full year, demonstrating our ability to manage high-acuity populations and to design, benefit and premium structures that win in the marketplace".
Aetna is enhancing confidence by increasing investment spending, despite expectations for greater utilization. The company is capable of driving 5% organic growth, as demonstrated by significant enrollment gains in the commercial segment. In addition, I also like Aetna's reserved approach towards Medicare and Medicaid, which will face much-needed trimming. At the same time, the company is expected to grow Medicare Advantage enrollment by around 30K members y-o-y.
Consensus estimates for Aetna's EPS forecast that it will decline by 0.8%% to $5.13 in 2012, and then grow by 9.9% and 11.7% in the following two years. Assuming a multiple of 12x and a conservative 2013 EPS of $5.57, the rough intrinsic value of the stock is $66.84, implying 42.5% upside.
United has recently demonstrated strengths in its own right. It was selected by Nebraska as the state's new administrate from medical and prescription drug programs. This mandate follows similar successes in Washington and Hawaii. The state covers 30K lives. At the same time, the company's acquisition of XL Health was a smart strategic investment. XL Health will help penetrate the 'severely ill' market; it serves more to fortify United's market share rather than drive significant EPS accretion. I am, however, concerned with how the company leads with regards to leverage to Medicaid, which I anticipate will face greater rate pressure.
Consensus estimates for United's EPS forecast that it will grow by 2.1% to $4.83 in 2012, and then by 12.6% and 10.8% in the following two years. Assuming a multiple of 13x and a conservative 2013 EPS of $5.33, the rough intrinsic value of the stock is $69.29, implying 24.5% upside.
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