UnitedHealth: Earnings Preview

| About: UnitedHealth Group (UNH)
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Health insurance industry bellwether, UnitedHealth Group Inc. (NYSE:UNH), is slated to announce its second quarter 2011 results on July 19, 2011, before the opening bell. The current Zacks Consensus Estimate is 93 cents per share for the quarter, projecting a year-over-year decline of 5.64%.

With respect to earnings surprise, UnitedHealth has consistently outperformed the respective Zacks Consensus Estimates, over the trailing four quarters. The average earnings surprise was 29.17%, implying that UnitedHealth has outpaced the Zacks Consensus Estimate by the same magnitude over the last four quarters.

First Quarter in Brief

In the first quarter of 2011, UnitedHealth’s reported operating earnings of $1.22 per share, beating the Zacks Consensus Estimate of 89 cents, led by lower medical utilization as more and more Americans stayed away from hospitals. Revenues exceeded $25.43 billion, an increase of nearly 10% year over year. Product revenues grew 23%, fee revenues advanced 17%, and premium revenues climbed 9% year over year.

Operating margins were stable at 8.7% in the first quarter, with a strong mix of higher margin service revenues that were partially offset by a 10 basis point year-over-year increase in both the medical care and operating cost ratios.

With higher revenues, a slightly lower tax rate, and fewer average shares outstanding, first quarter net earnings grew 18% to $1.22 per share. These earnings were supported by strong cash flows from operations of more than $1.2 billion.

Looking Forward

Based on the upbeat first quarter results, UnitedHealth upped its fiscal 2011 guidance. The company now expects full-year revenues to approach $101 billion, marking a $2 billion hike from its November forecast and a $7 billion increase over 2010 results.The company anticipates fiscal 2011 earnings per share to range between $3.95 and $4.05, an increase of 40 cents from the mid-point of the range.

Estimate Revision Trend

For the second quarter of 2011, four of the 19 analysts covering UnitedHealth have raised their estimates over the past 30 days and two analysts have raised their estimates over the past seven days. However, there were no estimate downgrades over both time periods.

Our Take

We expect the typical seasonal earnings pattern in commercial benefits, along with the potential 15 cents per share assessment relating to policy holder claims of Penn Treaty, to pressure results on a sequential basis, which could be compensated by a lower level of health care utilization. Moreover, the company’s Health Services business Optum is also expected to report slightly higher operating costs as the company continues to invest in it. As such, we anticipate second quarter net earnings per share to be meaningfully below the first quarter figures.

The company’s health benefits business UnitedHealthcare is expected to grow with its reputable service, value and innovation of affordable benefit products, combined with balanced and trusted local market engagements. The unit has witnessed an increase in memberships even amid a soft employment scenario.

UnitedHealth’s health services, branded under Optum, are also likely to perform well over the course of this year. Management is considering the expansion of the health service business to 30–40% of operating earnings over the longer term, and the company has been making acquisitions in the area. Currently, health services generate about 20% of operating earnings. Management thinks that the company is under-penetrated in the health service area and that investment in this field will reap benefits over the long term.

In May, UnitedHealth raised its annual dividend by 30% from 50 cents. The company had hiked its annual dividend to 50 cents in May 2010 from a mere 3 cents. Its annualized 10-year dividend growth rate has been 52.2%. Moreover, UnitedHealth’s strong cash flow from operations further hints at its strong longer-term cash flow prospects. Management expects cash flows to strengthen in the range of $5.8–$6.2 billion.

Further, shareholder’s return will be maximized with regular share repurchases. Historically, the company has favored share buybacks and mergers over dividend payments to deploy capital. UnitedHealth spent $620 million in the first quarter of 2011 to buy back 15 million shares, and it expects to spend $2 billion to $2.5 billion for repurchasing shares in full-year 2011. The company has recently approved the buyback of 110 million shares, which is about 10% of UnitedHealth’s outstanding shares, for about $5.3 billion. The company’s solid capital management is reflected in its return on equity, which has averaged at 18.97% for the past five years.

We currently have a Zacks # 2 Rank (short-term Buy recommendation) on the stock.

A Quick Look at Peers

The other four leading health insurance companies Aetna Inc. (NYSE:AET), WellPoint Inc. (WLP), Humana Inc. (NYSE:HUM) and CIGNA Corp. (NYSE:CI) are scheduled to release their second quarter 2011 earnings within a fortnight of UnitedHealth’s earnings release. While WellPoint and Aetna would report on July 27, followed by Humana on August 1, CIGNA would come out with its earnings report on August 4.

All of these insurers exceeded the Zacks Consensus Estimate in the first quarter, owing to their favorable performance. There was some investors' skepticism at the start of the year as to how the companies would fare, with the minimum medical ratio provision getting affected this year. However, the results of the major companies showed that the provision did not impact their earnings siginificantly.

We expect earnings upbeat in this quarter as well from all the major players owing to low medical utilization, favorable business performance, easing of the Health Care Act uncertainty, increased share repurchases and dividend hikes.