The health care sector, in general, has been outperforming the broader market by quite a wide margin in recent times. The sector was the best-performing sector in the S&P 500 last year. The Affordable Care Act, also known as Obamacare, is making some big changes, and insurance stocks particularly are seeing major changes.
UnitedHealth Group (UNH 0.20%) is one of the strongest players in the health insurance sector. The company' shares gained 41% last year, and have tacked on a further 9% year to date. But, despite the healthy gains, the shares trade at a modest forward P/E ratio of 14, which is well below the average forward P/E ratio of 17.3 for health care stocks in the S&P 500.
Source: YCharts
Perhaps the best part of the UnitedHealth story is that the company sports the highest return on equity for health-insurance stocks.
Source: YCharts
Investors contend that many health-insurance companies are stingy with dividends... and they have a point. UnitedHealth Group shares yield 1.37%, Aetna (AET) yields 1.2%, Humana (HUM -0.77%) yields 1%, WellPoint (ELV -1.06%) yields 1.8%. For an income investor, UnitedHealth Group's dividend yield does not look very attractive.
But, let's not forget that the company has been growing its dividend at a robust pace. Five years ago, the per-share annual dividend of UnitedHealth stood at just $0.03 -- right now, it's at $1.12. Moreover, the cash payout ratio for the company is still quite low at just 20%, which implies that it can easily continue increasing its dividend payouts without any difficulty.
Dividend yield, however, is just part of the equation. The return on any shareholder's investment is determined by other factors that are quite often overlooked by investors, such as share buybacks and the effects of debt reductions.
Many investors are quite familiar with share buybacks, but not very well-versed with the advantages of debt reductions. Funds borrowed by a company needs to be repaid with interest. In a low-interest environment, this might not be a big problem. But, when interest rates start rising rapidly, then a company can easily find itself paying too much money for accrued interest on its debts. This is money that can be used for more useful purposes such as acquisitions.
When you factor these into UnitedHealth Group shares, its total shareholder yield more than triples, to 4.47%, which is quite attractive.
Source: YCharts
Other reasons to like UnitedHealth Group
The Affordable Care Act, or ACA, has imposed profit and cost caps for health care providers. UnitedHealth pegs the cost of ACA and Medicare Advantage rate cuts for fiscal 2014 at $1.50 to $1.60 per share. The company's management, however, estimates that it can still equal fiscal 2013's EPS of $5.50 in 2014, through a combination of market share growth and cost controls. UnitedHealth covers 35 million enrollees through Medicare/Medicaid and individual plans. The company expects to grow the number of covered lives by 25 million through the expanded Medicaid.
Humana investors may not be as lucky as UnitedHealth investors, because the company is expected to feel the pinch of the planned cuts on the base government pay rates. Humana will be subjected to base government pay rate reductions of 4% starting next year. About 30% of Medicare beneficiaries chose the Advantage Plan over the regular government program.
Aetna is unlikely to feel the effect of the cuts -- at least for now -- mainly due to the earnings accretion of its Coventry acquisition. The acquisition provided a great boost to the firm's bottom line, and helped it grow by 43% in fiscal 20vat13. The firm's balance sheet also shows low leverage, which further adds to the attraction.
Aetna's CEO Mark Bertollini had earlier in the year expressed concerns that Obamacare had failed to achieve its main objective, which is to give medical coverage to the uninsured. He even went on to say the company might be forced out of the program.
But, overall, Obamacare accounts for just 3% of of Aetna's revenue. According to Mr. Bertollini, the program will have a net negative effect on the company's bottomline.
WellPoint is, perhaps, one of the health insurance companies that stands to benefit the most from Obamacare. The company's 500,000 enrollees are already quite profitable, and any extra enrollees will simply be the icing on the cake for the company. Despite this advantage, WellPoint has been working hard to grow its membership in 2014, and projects that its membership base will grow by 3%-4% in the current year, which should see its topline expand by 4% and the operating gain to come in at 5%.
WellPoint is optimistic that it will continue seeing the positive impact of ObamaCare on its business, and recently raised its full-year EPS guidance from $8.00 to $8.20, with an EPS of $9.10 in fiscal 2015 sitting squarely at the cross hairs.
Overall, Aetna and Humana look to be the hardest hit by Obamacare, and both announced that they will earn negative margins from the program in 2014. With the proposal to force medical insurers to increase the size of medical provider network that they provide to their customers, things might not get any better for them.
Foolish bottom line
UnitedHealth Group is not a classic dividend champion, and its dividend yield is not on an equal footing with the dividend leaders. But, when you factor in the company's share buybacks and the effects of debt reduction, the total shareholder yield improves considerably. This, paired with smart positioning and growth, paints a picture of a potentially bright future.
