As the Supreme Court debates the validity of the healthcare reform law, investors should definitely provide increased volatility for health insurers. In this article, I will run you through some operating projection of Aetna (AET) and then compare the fundamentals to UnitedHealth Group (UNH), WellPoint (WLP) and Cigna (CI). I find that all of the companies, save UnitedHealth (for now), are meaningfully undervalued.
First, let's begin with an assumption about Aetna's top-line. The company finished FY2011 with $33.8B in revenue, which represented a 1.4% decline off of the preceding year. I model growth trending from 5% to 10% over the next half decade.
Moving onto the cost-side of the equation, I project that operating expenses will eat up 91% of revenue versus 1% for capex. Taxes are estimated at 33% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model).
From a multiples perspective, the company is attractively priced. It trades at a respective 9.5x and 8.8x past and forward earnings versus 12.5x and 10.8x for UnitedHealth, 10.1x and 8.5x for WellPoint, and 10.1x and 8.2x for Cigna. Assuming a multiple of 11x and a conservative 2013 EPS of $61.82, Aetna's stock would hit $61.82, implying 24.6% upside.
Aetna delivered strong execution at the end of 2011. 54% growth over 4Q10 was a particularly impressive note. Increased investments and a conservative approach to handling Medicaid and Medicare further boost the risk/reward.
Consensus estimates for Cigna's EPS forecast that it will grow by 4.4% to $5.44 in 2012, and then by 11.2% and 14.5% in the following two years. Assuming a multiple of 9.5x and a conservative 2013 EPS of $6.01, the stock would hit $57.10. Management similarly delivered strong execution at the end of 2011, showcasing attractive momentum across the board. The Health Spring acquisition will also allow for meaningful revenue synergies by expanding into Medicare.
Consensus estimates for UnitedHealth's EPS forecast that it will grow by 1.3% to $4.79 in 2012 and then by 12.9% and 10.4% in the following two years. Assuming a multiple of 11x and a conservative 2013 EPS of $5.31, the stock would hit $58.41. The company beat the consensus for EPS by 14% but nevertheless gave conservative guidance. ROE is expected to fall by around 150 bps over the next two years while margins come under pressure. Declines in free cash flow, coupled with greater net debt, will push the stock further down. Accordingly, I would recommend holding out for now and selling if shares increase more than 3%.
WellPoint is unique from all of these firms given its diversification away from Medicare Advantage - a "plus", in my view. With 34M medical members under its belt, SG&A will be a meaningful metric to watch. If it shows signs of trending downwards, WellPoint will surge in value. By consolidating its existing framework, the company has already made meaningful steps in unlocking value. The company's underwriting missteps are not really a reflection of the fundamentals, and I believe it is only a matter of time before the market concurs.
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