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Here's What UnitedHealth Investors Should Be Watching

By Motley Fool Staff - Jul 19, 2018 at 4:14PM

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The health insurance Goliath's financials are increasingly dependent on this important program.

UnitedHealth Group (UNH 1.53%) just reported a 12% year-over-year improvement in its second-quarter revenue. However, its growth wasn't due to more employees signing up for its plans through their employers. Instead, it was largely the result of seniors' ongoing embrace of Medicare Advantage health insurance plans. Will aging baby boomers be the biggest driver of future growth at this insurer?

In this clip from The Motley Fool's Industry Focus: Healthcare, analyst Kristine Harjes is joined by healthcare investor Todd Campbell to explain why government programs are becoming increasingly important to UnitedHealth's future.

A full transcript follows the video.

This video was recorded on July 18, 2018.

Kristine Harjes: The massive $245 billion market cap UnitedHealth Group, ticker UNH, reported earnings yesterday. Expectations were pretty high, but the company managed to beat them yet again. Quarterly revenue of $56.1 billion, was up 12% year over year. Earnings from operations of $4.2 billion was up 13% year over year. Adjusted EPS of $3.14 per share was up 28%. Todd, what stood out to you in this quarter's report?

Todd Campbell: I want everybody to write down those figures and keep them in the back of your mind as we're having this conversation. Revenue up 12%, operating earnings up 13%, EPS up 28%. Those are all things that you want to see, especially for a company as big as this. They did $56.1 billion in revenue. If you break that out, nearly $46 billion of that came from their insurance business, premiums that are being paid for health insurance.

UnitedHealthcare is the nation's largest health insurer. They insure 48.8 million people, and they do a tremendous amount of business in the commercial market, the employer business, offering plans to people who are at work, work for other people or companies. And, they have a small individual business. But it's not the commercial business that's behind this double-digit growth.

Harjes: Yeah, what really seemed to drive it was their government insurance programs, their Medicare and Retirement segment. That business segment grew revenue 12.6%. The number of people in the segment grew 10.4%. When you look at what's really driving the bottom line here, it's Medicare, it's Medicare Advantage, it's Medicaid.

Campbell: You had 26.3 million commercial members insured. That was down from 26.9 million year over year. You actually lost 600,000 members in the commercial business. Yet, that represents more than half of the membership that the company has and handles. So, yes, Medicare and Medicaid are moving the needle for UnitedHealthcare. Medicare Advantage plans, they saw their enrollment up more than 10%. They have 4.8 million people now in Medicare Advantage. Supplemental, they went to 4.5 million people to 4.36 million people. Medicaid, they went to 6.7 million people from 6.4 million people. So, they are getting a tremendous tailwind from their government programs, and that's more than making up for what we'll call a flatline in its commercial business. I guess that makes sense, because unemployment is 4.1%. How many more people can you employ at this point?

Harjes: Right, that's a finite number of total people that are commercially insured.

Campbell: Yeah, absolutely. I think there are some takeaways here that investors are going to have to be paying attention to when it comes to UnitedHealthcare. If you're interested in investing in large healthcare companies, I think you have to consider insurance companies. Of all of the insurance companies that are out there, UnitedHealthcare has to be at the top of the list of companies to have on your list. However, you're going to need to pay particular attention, as we go from here, specifically to that Medicare and Medicaid business.

I happen to think, I don't know if you agree with me, that there are some very big natural tailwinds that could support ongoing growth. Maybe you don't get consistent growth of 10% year over year out of this company forever. But the number of people who are going to be covered by Medicare and Medicaid is going to soar between now and 2050.

Harjes: Yeah, that's a huge demographic tailwind behind it. I don't think anyone's arguing with that.

Campbell: 83.7 million people by 2050. That's almost double where we were in 2012. That's age 65 and up. UnitedHealthcare is the largest player in the Medicare market. They have a 24% market share by enrollment, according to the latest research by Kaiser, which tracks this kind of stuff. If we assume that baby boomers are going to continue to get older and Medicare will still be around, it's probably safe to assume there are going to be a lot of people who are going to choose Medicare Advantage. Kaiser's research shows that enrollment in Medicare Advantage plans is up 71% since just 2010.

Harjes: Another note that I want to point out on UnitedHealth is that where they stood out in this quarter was on the bottom line. They were able to control expenses really well, specifically their Medical Care ratio, which is a measure of how much they're spending on medical costs as a percentage of total revenue. That dropped by 30 basis points to 81.9%. They're expecting that to come in around 81.5% for the year. This is a remarkably consistent number. This is company that is, quarter after quarter, able to keep its expenses in line.

Campbell: That's the big thing. They're investing very heavily in the use of technology to help prevent expensive care. They want to create more price transparency so that their members can go out and actually comparison shop for services. That could save a lot of money, help keep that MCR down.

They're also doing some really interesting, laying the ground work for any kind of a shift toward value-based care, away from fee-for-service care. Of course, that could also help them control some costs and continue to reward investors. The other thing that investors should recognize is that they're very aggressively buying back their stock. That's also supporting the bigger than expected increase on the bottom line.

Harjes: The share buybacks are kind of an interesting thing. This company is, on the surface, a pretty shareholder-friendly company, but their shares outstanding has been pretty steady over the last year or so, even going back before that. But, they have a new 100 million share buyback program that was just announced in June. If they do execute that without granting an excessive number of shares to their employees and whatnot, to level the other end of the seesaw there, that 100 million shares would bring their outstanding share count down about 10%.

They do have a dividend -- which you would expect for a company this big and this consistent -- but it's only 1.4%. It's supported with plenty of cash flow coming in. Their payout ratio is in the low 20s, so they could easily bump that even higher, although it does seem like their preference is to do more of the share buybacks. Which, if you think about the amount of political uncertainty and the amount of investment that you need to be doing just to keep up with the changes in the healthcare landscape, I think that seems like a reasonable distribution of capital.

Campbell: The only thing that I would say is, we'll pooh-pooh the 1.4% because that's less than the S&P 500. You could buy the SPY and get a higher dividend yield than buying UnitedHealthcare's stock. I think investors should also recognize that that dividend payout was just increased back in June by 20%. So, you have a relatively low payout, but they're making a commitment to increasing that dividend over time. A 20% increase in dividend for this year not bad at all, not shabby.

Harjes: Yeah, with a ton of room to grow, as well. Any final thoughts before we wrap up?

Campbell: I think, investors trying to figure out the puts and takes on this, the things to keep in mind ... if you go back to earlier in the show, talking about the epilepsy drugs, I think you just need to wait and see how this shakes out with the DEA scheduling of the marijuana drug, Epidiolex. That's going to be relatively important. If they get favorable scheduling, it can get prescribed, and refills can get prescribed more easily. That could increase its use relative to Zogenix's competing drug.

When it comes to the insurers, again, keep a close eye on policy in Washington and what ends up happening with Medicare and Medicaid going forward. It seems like that's really what's going to be driving the results of these big insurers over the course of the next few years.

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