UnitedHealth Today, Centene And Humana Tomorrow

| About: UnitedHealth Group (UNH)
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Summary

Managed care continues to gain share over fee for service.

Insurers are adapting to the market change slowly, but managed care companies are prospering.

The new environment benefits old-fashioned HMOs like Humana.

UnitedHealth Group remains by far the strongest of the group.

The politics of healthcare can confuse investors as to what is really going on.

The politics sound like big insurers lining up with Republicans, condemning "Obamacare" and "withdrawing" from its exchanges. UnitedHealth Group (NYSE:UNH) and Humana (NYSE:HUM) have both loudly proclaimed their disgust with the exchanges, leading many to conclude (wrongly) that they have been a failure.

What is really going on is a sea change in how the health insurance business operates. It's a move away from "fee for service," which dominated employer-paid insurance for decades, toward "fee for patient" managed care.

Ever since the ACA was signed, managed care companies have been advancing in the market, taking patient share through Medicare and Medicaid contracts, and moving slowly toward the individual market of the exchanges. Since the law was signed, in March 2010, Centene's (NYSE:CNC) shareholders have seen a gain of over 650%, as the company has grown through contracts and acquisitions to a profitable $22.7 billion behemoth valued at $12.2 billion.

Managed care profits aren't enormous - Centene's net income represents just 1.5% of revenues - but once a provider figures out how the business works, both top- and bottom-line growth can be steady.

The mainline insurers whose mergers are being rejected by the Justice Department - Aetna (NYSE:AET), Humana, Anthem (NYSE:ANTM) and Cigna (NYSE:CI) - all focus on selling employer-paid plans that are fee-for-service. There is a wide choice of doctors, a continual back and forth on payments, but seriously ill people get a very good deal once out-of-pocket maximums are reached.

The problem is that you can't have an unlimited draw from a limited pool. A small number of very sick people, able to see any doctor and seek any cure, can do serious financial damage. Managed care companies, by contrast, limit the size of their networks, and under the ACA, patients are also on the hook for a portion of their bills, giving them "skin in the game" and a financial incentive to follow insurers' recommendations.

The model the market is moving toward is the one Humana pioneered two decades ago, the Health Maintenance Organization. Under the ACA, such companies finally have the legal and financial framework to enforce their rules on best practices, on the use of data to determine treatment, and on compliance with doctors' orders. Under these circumstances, Humana should have an advantage.

If you are interested in buying a company in this space, however, I can't recommend UnitedHealth highly enough. Publicly it is resisting the move to the exchanges and managed care. Privately, it's joining it with a start-up unit called Harken Health. UNH is also the unquestioned leader within the group in health IT, having spent a decade building its Optum unit.

In its latest quarterly report this week, UNH reported earnings of $1.76 billion, or $1.96/share, on revenues of $46.485 billion. That is more than twice the revenue of Anthem, which sits second, and includes over $20 billion from various units of Optum, up 52% year over year. The star of the group is OptumRX, the pharmacy benefit manager, which brought in $15.1 billion by itself.

The company spent the last decade buying health IT companies, eventually forming a powerhouse called Optum whose revenues grew 52% year over year in this report to over $20 billion. Technology revenues were up 25% to $1.8 billion, the delivery business called OptumHealth was up 18% to $4.1 billion, and the pharmacy business called OptumRX was up a whopping 69%, mainly on acquisitions, bringing in $15.1 billion in revenue compared with about $25 billion pulled in by the leading PBM, Express Scripts (NASDAQ:ESRX).

United's superior earnings power makes it the stock to own today, but the managed care opportunity makes Humana and Centene good bets for tomorrow.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.