Due to fears surrounding the stock market fall nearly half a decade ago, financials still remain heavily discounted today. As an investor relations consultant, I see strong upside for smaller under-followed firms Investors Heritage Capital (IHRC.OB) and Citizens Financial Corporation (CFIN.PK) as press coverage improves. These companies are heavily undervalued, and I plan on emphasizing this in a later focus piece.
In the meanwhile, larger insurers will receive a disproportionate amount of attention. In this article, I will run you through my DCF analysis on UnitedHealth Group (UNH) and then triangulate the result with an exit multiple calculation and a review of the fundamentals compared to Aetna (AET) and CIGNA Corporation (CI). I find meaningful, but not exceptional, upside for the company.
First, let's begin with an assumption about revenues. UnitedHealth finished FY2011 with $101.9B in revenue, which represented an 8.2% gain off of the preceding year. Analysts model a 10.9% per annum growth rate over the next half decade, and I view this as reasonable since it is more or less in-line with what is expected for the S&P 500.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model OPEX at 92.5% of revenue, capex at 0.9% of revenue, and taxes at 34% of adjusted EBIT (considering non-cash depreciation charges).
We then need to subtract out net increases in working capital. I estimate that this will hover around 0.3% of revenue.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10% yields a fair value figure of $66.80, implying 25% upside. This is just around the threshold that I consider merits calling the investment a "value play", so it is not exceptionally undervalued.
All of this falls within a strong context:
Good morning, and thank you for joining us as we wrap up 2011 and discuss the potential we see to better serve our customers and markets in 2012. We're committed to continuing to elevate our performance this year as we outlined in our Investor Conference just about a month ago.
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.
From a multiples perspective, UnitedHealth is also fairly attractive. It trades at a respective 11.3x and 9.9x past and forward earnings versus 8.8x and 8.1x for Aetna and 9.5x and 7.7x for Cigna. Assuming a multiple of 13x and a conservative 2013 EPS of $5.33, the rough intrinsic value of UnitedHealth's stock is $69.29.
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. The company delivered a strong close to 2011 with a 54% growth over 2010 in the fourth quarter. By increasing investment spending and taking reserved approach to Medicare and Medicaid, the company is reducing risk while taking advantage of core opportunities.
Cigna will benefit from the Health Spring acquisition, which offers significant cost and revenue synergies. The firm now has the capability to upsell ASO-based enrollees in its Commercial business. Strong fourth quarter momentum and fourth quarter increases in scale make render the company undervalued. Assuming a multiple of 9x and a conservative 2013 EPS of $6.22, the rough intrinsic value of the stock is $55.98.
Disclaimer: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.