How UnitedHealth Can Impress Next Quarter

UnitedHealth (NYSE: UNH  ) is one of the largest health insurers on the planet. The company achieved $122 billion in revenue in 2013 and achieved a 4.5% increase in total revenue for Q1, (thanks in part to its data analytics and technology segment, which is growing at a rapid clip). It also plans to return $4 billion this year through buybacks and dividends, including a recently announced 35% dividend increase.

That's the good news.

The bad news is that despite a strong 39% gain last year and another 9% tacked on so far in 2014, the stock is facing some major headwinds. Notably, UnitedHealth has significantly underperformed several of its competitors since the beginning of this year, including WellPoint (NYSE: ANTM  ) and Aetna (NYSE: AET  ) . To date, Wellpoint is up 22%, and Aetna, 20 %, both of them more than doubling UnitedHealth's performance so far this year.

Merely an off year?
With Obamacare clawing its way through health care, turning winning companies into losers in an eye blink, it's not a good time for investors to go to sleep on even great stocks like UnitedHealth.

It's possible the company is merely taking a breather. With five consecutive years of gains under its belt, an off year could certainly be in the cards. But it's worth digging deeper, because something more dangerous may be afoot with this insurance behemoth.

So let's dig a little deeper.

In the Q1 conference call , UnitedHealth's management blamed ACA's "systematic underfunding" of Medicare Advantage and sequestration for reducing earnings per share by nearly $0.35 in the quarter. Another culprit for the company's weaker bottom line (net earnings fell to $1.1 billion from $1.2 billion in the year-ago quarter) was a huge spike in hepatitis C drug use, driven by Sovaldi, the new $84,000 hep-C treatment from Gilead Sciences.

As you may recall, the overall dismal tone of the conference call triggered a nosedive in the health insurance sector. (UnitedHealth often acts as a bellwether, being the first to report, as well as the biggest insurer.)

But then Aetna came in with superb Q1 numbers. Aetna reported that operating earnings per share increased 27% year-over-year, medical membership jumped by 500,000, and operating revenue soared by 47%. The good news just kept coming.

When WellPoint's call was equally positive, the health insurance sector promptly resumed its upward trajectory. Unfortunately, ever since UnitedHealth has lagged both those companies in performance.

Bottom line: UnitedHealth has experienced pricing pressure more acutely than peers such as Aetna and WellPoint. But those insurers face their own specific pressures as well, and they didn't make nearly as many excuses in their conference calls.

Another factor comes into play here. Right now, all major insurers are still trying to grasp how their costs are changing now that they can no longer cherry-pick their customers. But UnitedHealth was the only insurer who sat it out on the sidelines.

"Second mover" advantage? You gotta be kidding
Initially, UnitedHealth offered coverage in only a handful of exchanges. They've added a few more since, but competition is growing stiffer in the government-run marketplaces.

UnitedHealth is now in a catch-up position, as other insurers harvest the gains from being early entrants. In addition, they badly damaged their reputation, as shown by the press flap when one of United's former client's, Edie Littlefield Sunby, was dumped. Ms. Sunby, a stage-4 gallbladder cancer patient, lost her coverage when UnitedHealth pulled out of California's individual health care market.

The company's justification for leaving individual state markets was that they wanted their competitors to swallow the first wave of sicker enrollees. UnitedHealth's plan was to scoop up the profit by entering later -- when healthier people signed up for coverage. Citing concerns about "pent-up appetite" for medical care, CEO Stephen Hemsley said at the Sanford C. Bernstein conference on October 1, "We are approaching them with some degree of caution because of that."

As it turned out, health care service utilization for "first movers" has not been as great as expected, so UnitedHealth gained little by playing a waiting game. On the downside, their enrollment slid and they lost market share. Even the smaller regional players saw gains from being early entrants, and companies such as WellPoint added nearly 600,000 new customers via the exchanges.

The policy of being too cautious is the greatest risk of all
Will UnitedHealth right their ship? I believe they have bungled things thus far with the health care exchanges, but as T.S. Eliot said, "Success is what we make of the mess we've already made of things."

The ranks of insured Americans will balloon by 12 million people this year, according to the Congressional Budget office. That's the main reason for the blockbuster performance of the health insurance sector. With their size and financial strength, UnitedHealth should be one of the largest beneficiaries of health reform -- but only if they get off the sidelines.

Key takeaways from UnitedHealth's upcoming conference call will be the latest on hepatitis c treatment, the probable continued strength of Optum, and, perhaps most importantly, whether company management stops the blame game with health care reform and starts playing more aggressively. Time will tell.

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