UnitedHealth Group has hit a slow patch for earnings growth, and its stock is a touch pricier than those of its peers. That combination might not look inviting for either growth or value investors, but both should consider buying shares. United (ticker: UNH) is poised for a return to peppy growth in coming years—and an even faster rise in free cash flow. That could bring bigger dividend payments and plenty of share repurchases. The stock price could rise 40% over two years.
Over the past decade, United’s earnings per share more than tripled, but Wall Street expects the nation’s largest health insurer to generate a meager 3% increase this year, followed by 7% next year. As the economy improves, patients who’ve been skimping on health care to save on co-payments are expected to return to their doctors, raising costs for insurers. Also, Obamacare next year will cut payments for lucrative Medicare Advantage plans, sold by private insurers like United as an alternative to standard Medicare.
Shares of United sell for 12 times this year’s earnings forecast, versus 15 times for the Standard & Poor’s 500 index. Investors can find bigger discounts with Aetna (AET) and Cigna (CI) at 11 times earnings or Wellpoint (WLP) at 10 times. But United seems a better buy, for two reasons.
The first is Optum, United’s hodgepodge of fast-growth health-care businesses. It provides information-technology services, like Cerner (CERN), which trades at over 30 times earnings, and prescription plans, like Express Scripts (ESRX) at 15 times earnings. There’s a mental-health and drug-counseling business that competes with Magellan Health Services (MGLN), which goes for 15 times earnings, and a preventative-care operation, like Healthways (HWAY), which sell for more than 50 times earnings.
HEADWINDS IN United’s larger health-plan business are masking Optum’s fast growth, but that should soon change. By 2015, Optum will contribute 29% of operating earnings, up from 16% last year, according to Chris Rigg, an analyst at Susquehanna Financial Group. Wall Street expects earnings per share by then to hit $6.46, a 19% increase from this year’s forecast. As Optum’s growth becomes more obvious, the stock’s premium to the health-plan group will increase, Rigg predicts. At 14 times the 2015 forecast, it would fetch about $90, or 38% more than the recent price of $65. Add to that a 1.7% yearly dividend yield.
There’s more to like about Optum than fast earnings growth. With health insurance, more customers means more premiums collected, but also more cash that must be set aside for future health-care claims. Cash demands for Optum are much smaller, so United’s free cash flow is likely to expand faster than its earnings in coming years. Wall Street is projecting $7.8 billion in 2015, up from $5.5 billion this year. Calculated against today’s price, that will make for a free-cash-flow yield of nearly 12%.
Date: JULY 6, 2013