Why UnitedHealth Group Has Been a Top Stock in 2016 So Far

Investors came into 2016 nervous that Obamacare losses would derail UnitedHealth Group's (UNH 2.96%) profitability, but improving profitability for UnitedHealth's other businesses and Donald Trump's anti-Obamacare platform has investors exiting the year far more optimistic.

An improving outlook has made UnitedHealth's shares one of the best performing big-cap healthcare stocks in 2016. Can the company's good fortune carry over into 2017? In this clip from The Motley Fool's Industry Focus: Healthcare podcast, analyst Kristine Harjes and guest Todd Campbell discuss UnitedHealth's performance this year and unpack its future opportunity to profit from an Obamacare repeal.

 A full transcript follows the video.

This podcast was recorded on Nov. 18, 2016.

Kristine Harjes: Todd, are you ready to talk about our third and final stock that healthcare investors should be thankful for this year?

Todd Campbell: Absolutely, and this one's going to be a little bit different, because we're not talking about two smaller stocks that doubled or more, we're talking about a giant in healthcare. That company is UnitedHealth Group.

Harjes: Yes. This is the largest health insurer in the United States. It's been steadily climbing higher all year. It's up about 27% from January 1st.

Campbell: Yeah, a huge move, and huge out-performance for a big-cap stock versus the S&P. What's interesting about this company is, similar to the other two companies we talked about, there were a lot of reasons to have some concerns going into the beginning of 2016 with UnitedHealthcare. They had just come out of December saying, "We think we're going to lose hundreds of millions of dollars on Obamacare-offered insurance plans this year, and that's going to be a drag on what we think we can deliver în EPS (earnings per share)." At the beginning of the year, I think they were forecasting about $7 in earnings this year. Boy, they lowballed that, because their performance this year is much better than that. Of course, with the outcome of the election, there are a lot of people thinking they could have significant tailwinds if Obamacare is completely rolled back.

Harjes: Right, exactly. Obamacare could be a good thing and a bad thing for this company. We were talking earlier about Obamacare and how it relates to UnitedHealth, and you mentioned it could be a headwind to their Medicaid segment, but a tailwind to their individual market segment. Could you unpack that a little bit?

Campbell: Yeah. Their fastest-growing piece of their business has been the Medicaid part of their business. That's essentially where they run state Medicaid programs. If you go back in the way-back machine and start thinking about, what did ACA/Obamacare do? One of the things that Obamacare did is allow states to opt into Medicaid expansion. 30+ states chose to decrease the qualification criteria for Medicaid, allowing millions more people to come onto the Medicaid rolls. That has actually been very profitable for UnitedHealth and many others. That's something we're going to have to walk very carefully as investors, because while on the surface, we may say, "Wow, there's a lot about Obamacare that is a drag on profitability," there's a health insurance fee that gets charged to health insurance companies for participating in the market place. This year, I think that fee is going to cost UnitedHealth Group about $1.8-1.9 billion. You have the losses that are, theoretically, going to trail off now, from offering those plans in those states. And you also have deregulation that could free them up as far as pricing and how they insure and who they insure, that could provide tailwinds. And then some of that will be offset, potentially, by this Medicaid side of the business. 

Harjes: Exactly. Something that is important to watch out for with UnitedHealth is called the medical loss ratio. The government mandates that at least 80% of the premiums that an insurer collects be paid out then for healthcare costs and quality improvement activities. So then you only have 20% of that premium money left over to pay for your administrative, your overhead, your marketing, all of the things that form your operating cost ratio. Then, after that, that's what you have left as profit. So, as an investor, when you're looking at this company, what you want to see is, that 80% is essentially what you're at. You don't want to be too far from that 80%. You also want to see your operating cost ratio be pretty low. On both of these measures, UnitedHealth has done very well, something like 80.3% of their premiums --

Campbell: That's exactly what it is, Kristine -- 80.3% on the cost ratio. They're coming right in as low as they can on that.

Harjes: And that's really great for this company. They also have a couple of other really awesome things going for them, for example, their Optum segment is growing like a weed. This was something that we knew going into 2016, that this would be an important business segment. Probably the most important part of it of all is the PBM, the pharmacy benefits management part of it, which is called Optum Rx. Back in 2015, there was an acquisition of Catamaran PBM. We knew that was going to give them some economies of scale. We're starting to see that hit, where the Optum segment is truly taking off.

Campbell: Yeah. Healthcare data analytics is a huge area for Optum and a huge potential growth driver. They deal with so many patients, and they have so many data points that they can leverage to try and figure out how to cut costs out of their system, how to treat patients better, that it should provide tailwinds throughout the industry. Especially since health insurance and health provider costs aren't going lower, they continue to trend higher. So the need for these kind of technology innovations still remains very high for this industry.

Harjes: For me, at least, looking at the three companies we talked about today, UnitedHealth seems like the best buy at them all. It's maybe not as red-hot as the other two are, but it is strong, steady and growing. What do you think?

Campbell: I think, especially if you're an income investor, because it is the only one of the three that actually pays a dividend --

Harjes: It's a solid diffidence, it's 1.64%, that's on a 32% payout ratio. That's two thumbs up.

Campbell: That's not bad at all, especially for a company whose share price just climbed 30%. That's good, too. So, yes, for income investors, absolutely. If you're a little bit more growth-oriented, you have a little bit longer time horizon, maybe I would lean a little bit more toward Exelixis, only because they have a chance to turn profitable next year. I think the estimated loss for next year by analysts is about $0.02. So, there's a chance that if they overdeliver over the next two quarters that they could actually start to break even next year. Obviously, that could create some excitement there.