Good companies may stumble, but they seldom ever fall flat on their face and so it seems with UnitedHealth (NYSE:UNH). There were some concerns about the company coming out of the first quarter, but while the stock is not leading the group it is also not lagging by much. Price competition and enrollments always merit watching, but the Optum platform and the company's expansion into Brazil continue to offer some boosts to growth.
Looking back at a challenging first quarter
The first quarter included some operational missteps that are not all that common to see from UnitedHealth. Operating income declined 4% in part due to a 3% increase in medical costs. Most significantly, management indicated that there were surprised by the size of the impact of Sovaldi this quarter – about $80 million of $100 million in Hep C spending.
Management also reported weaker enrollment than expected, as risk-based and fee-based commercial enrollment both declined about 4%. Curiously, while other insurers/admins like WellPoint (NYSE:ANTM), Aetna (NYSE:AET), and Cigna (NYSE:CI) expressed a pretty benign view on industry pricing, UnitedHealth mentioned increasing price competition. Context is important in this case, though – UnitedHealth is seeing intensifying competition in New York and that is where about one-quarter of the company's commercial risk membership is located. So, everyone can still be telling the truth – nationwide, pricing is not an issue for WellPoint, Aetna, or Cigna, but it is a local challenge for UnitedHealth.
Medicare Advantage going through a readjustment
Medicare Advantage is a substantial portion of UnitedHealth's earnings base and the company has about 20% share of this market. It looks as though 2014 is going to be a more challenging year as the company restructures this business a bit. The company has trimmed back its physician network in several states to reduce costs and improve its STAR ratings (which at 3.5 slightly trail the industry average of 3.8). UnitedHealth also took repricing actions in certain states and that is going to create some near-term turbulence for enrollment and profits.
As a little background reminder, this is also a major market for Humana (NYSE:HUM), which holds 17% share despite being about one-third of UnitedHealth's size, and a somewhat significant one for Aetna as well roughly 7% share). WellPoint and Cigna do not participate to such large degrees. Medicare Advantage is, very simply put, a program designed to give those who are eligible for Medicare more choice in terms of managing their health care, allowing them to select plans from private insurance companies (that can include additional premiums).
More exchange participation?
Thus far the insurance mandate has not radically changed the U.S. health care landscape. Utilization isn't up all that much, procedure counts haven't soared, and insurance companies are not seeing loses balloon. While it's still early, UnitedHealth seems more inclined to participate in exchanges for 2015. As a reminder, UnitedHealth had one of the lowest participation rates in 2014 and while I don't think the company is likely to match Aetna, Humana, and WellPoint (all of which participated in double-digit numbers of states), there's certainly room to expand here.
Brazil and Optum continue to offer upside
UnitedHealth also continues to build businesses that can offer above-average growth potential. The company recently increased its ownership of Brazilian insurance company Amil to 90% and is reportedly interested in buying a 50% stake in DASA, the largest diagnostics lab company in Brazil. Brazil still represents a good long-term growth opportunity for UnitedHealth, as private insurance penetration is low but individual incomes are growing and so too are the burdens on the state-sponsored health system.
As far as Optum, UnitedHealth is still far from maximizing the potential of this platform in disease management, specialty benefits, care management, health care IT, and its PBM services. The PBM service expansion across its own insurance programs is probably easiest to achieve (or at least easiest to control), but the care management and IT opportunities represent sizable profit opportunities down the road.
The bottom line
The managed care sector has done pretty well over the past year, with UnitedHealth up close to 25% (and up about 13% since I last wrote on it), while Cigna, Aetna, and WellPoint have done even better. UnitedHealth remains undervalued if it can achieve 17.5% return on equity (or higher) in 2018 and that still seems like a reasonable assumption. Should UnitedHealth's stumbles reoccur, though, the reaction is likely to be a little severe as this is a company that has trained the Street to expect a high level of consistent execution.