August 26, 2004
Research Digest
www.zackspro.com
UnitedHealth Group
Nisha Malpani, B.Com(Hrs), C.A.
ResearchDigest@zacks.com
155 North Wacker Drive
Chicago, IL 60606
(UNH - NYSE)
$60.90 (As on 08/09/2004)
Overview
UnitedHealth Group Inc. offers health care coverage and related services to help people achieve
improved health and well being through all stages of life. The company's products and services reflect a
number of core capabilities, including medical information management, health benefit administration,
care coordination, risk assessment and pricing, health benefit design and provider contracting. With
these capabilities, it is able to provide comprehensive health care management services through
organized health systems and insurance products.
Analysts have identified maintenance of spread between medical revenue and costs, and proper
reserving for medical claims as the two important factors for UNH. Analysts are almost unanimous that
UNH is performing well in both areas. Medical loss ratio (MLR) or medical cost ratio (MCR) monitor the
company’s spread between medical revenue and costs. MLR and the MCR are the same metric.
The company recently closed the MAMSI, TouchPoint, and Great Lakes acquisitions, which added over 1
million people to its membership.
UnitedHealth led off the earnings season for the managed care industry with a strong earnings report
With signs of an economic recovery underway, pricing discipline holding and better enrollment growth,
the managed care group’s P-E multiple should start to rise again. Unlike the prior quarters, we feel
investors will discriminate among the managed care companies. United Health Group post 2Q04
earnings valuation jump shows that investors will reward high quality, differentiated underwriters.
Recent Events
The Company closed the acquisition of Oxford Health Plan (OHP) on 7/29/2004. The deal has closed
much faster than expected. The stock/cash deal values Oxford at $56.79/share (about $4.9 billion).
Under terms of the stock/cash deal, UnitedHealth will pay consideration of $16.17 in cash per share and
exchange 0.6357 shares of UNH for each share of OHP.
The majority of analysts view this as a positive financial transaction, which will provide potential operating
synergies to UNH. They also believe that the UNH/OHP combination will be a major competitor for NYC
based national accounts as well as local small and mid size group accounts. The deal is expected to
provide major economies of scale to the combined company and hence be accretive to earnings.
United is targeting several areas for cost savings, although it does not expect to eliminate many jobs due
to the merger. Instead, management is targeting cost efficiencies in areas including systems, real estate,
and improved provider discounts from increased bargaining clout. In terms of systems integration, United
plans to gradually migrate OHP membership to the new systems throughout 2005 and 2006.
© Copyright 2003, Zacks Investment Research. All Rights Reserved.
United announced on August 6 that it has entered into a strategic business and marketing alliance with
Harvard Pilgrim. The partnership will provide UNH's self insured members with access to Harvard's
provider and hospital networks in Massachusetts, New Hampshire, and Maine.
UNH recently disclosed Oxford’s 2Q04 results. UNH reported earnings for Oxford of $1.03 per share in
2Q04, compared to consensus of $0.96, before merger related costs of $0.04 per share, which brought
final net to $0.99. The upside was mostly attributable to a better than expected MLR, sequential decline
in its SG&A ratio.
The Company reported a rapid acceleration in Health Savings Account (HSA) sales activity across its
businesses, providing clear evidence of the enthusiasm for consumer-driven health programs. Bolstered
by comprehensive regulatory guidance from the U.S. Treasury Department, HSAs have advanced
consumer-driven plans beyond early stage models like Flexible Spending Accounts (FSA) or Health
Reimbursement Accounts (HRA) to create a more empowered consumer health purchaser.
Positive Arguments
 UNH is the industry leader in terms of
Negative Arguments
 Bearish analysts are concerned that
consistently
meeting
performance
targets.
The Company maintains one of the
highest operating and net profit margins
in the health and managed care
industry.
UNH has one of the highest returns in
the managed care industry.
High levels of returns combined with
robust and consistent historical results
lead many to conclude that UNH
deserves a premium valuation as
compared to its peer group
It also maintains one of the lowest
levels of indebtedness that enable it to
pursue aggressive share buybacks and
strategic acquisitions.
recent merger activity in the industry is a
sign that Company’s expect the
favorable operating environment of the
past few years to become more difficult.
An increased M&A landscape could
signal that organic growth will be harder
to come by and that cost reduction
through acquisitions may be pursued.
Those with a neutral bias on the shares
believe that a premium valuation is not
warranted for UNH. This arises largely
from skepticism on the ability to meet
future results, and that overall
competitiveness will increase.
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The combination of UNH & OHP creates a
stronger #2 competitor to WellChoice.
Unlike its peers, United Health Group’s
earnings power comes from a multitude of
business
units
whose
harmonious
collaboration ensure steady earnings
growth and resilience.
UNH had an impressive cash flow, which
equated to 1.7 times the net income in the
most recent quarter.
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Sales
The Company reported revenue of $8.7 billion in Q204 with all segments showing sequential and year
over year improvement and revenue improvement. Premium revenues were up 25% to $7.8 billion, partly
due to the inclusion of the Mid-Atlantic Medical business, as well as three other smaller acquisitions.
Management services/fee revenue increased 4.4% from the year-ago quarter to $813 million, and
increased $24 million sequentially.
The quarter was characterized by tepid enrollment growth. Management lowered 2004 enrollment
guidance for both UnitedHealthcare and Uniprise, since the recent improvement in the economy has not
yet translated into membership gains. However, it is expected that enrollment should gradually improve
over the next few quarters as the company is generating strong growth in its other product areas.
The average sales estimate for FY ’04 is $35.0 billion or 21.5% growth and that for FY05 is $40.1 or
14.6% growth.
According to an analyst (Bernstein), UNH’s price discipline will continue to put pressure on enrollment
and overall growth for the Company for the foreseeable future. The Company indicated that the majority
of health plans are pricing with discipline and that the company will stick to its strategy of competing on
service and innovation. United is willing to walk away from business where the pricing does not allow for
adequate margins.
UNH derives its revenue from five operating companies:
United Healthcare
This segment offers health benefit plans to individuals, small and mid-sized businesses. It also offers
health benefits to the beneficiaries of Medicaid through its AmeriChoice program. Revenue in Health
Care Services, UNH's largest division, was $5.0 billion, an increase of 30.9% year over year in 2Q04.
Ovations
Revenue in Ovations, the division focused on products for those over age 50, grew by 10.9% to $1.8
billion. The Medicare Choice product added about 5,000 new members in the quarter. Management
indicated that CMS has approved Ovations for three separate prescription discount card offerings.
Uniprise
This segment, providing health benefit solutions to the country’s largest employers saw top-line growth of
8.8% during the quarter with revenue of $843 million. Uniprise enrollment grew by 470,000 members
which included 50,000 new members from the acquisition of MME. Management indicated that it expects
600,000 new members in 2004, provided the economy continues to improve.
Specialized Care Services
This segment offers benefit plans in varied fields, such as dental, vision, and nursing among others. For
the quarter, the Specialized Care Services division increased its revenues by 23.8% from 1Q03, to $573
million. The continued strong performance of this business is particularly impressive given the state of
employee benefits.
Ingenix
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This segment provides health and pharmaceutical information and intelligence to physicians and other
health care professionals. The Ingenix division saw revenues increase 15.9% over 1Q03 to $146 million.
The declined performance from fourth quarter was driven by seasonality of the business.
Analysts believe that Ingenix can contribute both to United’s top line revenue growth by selling its
products externally, and can also support other divisions, such as UnitedHealthcare and Uniprise, to
lower administrative costs leading to margin expansion.
On a business segment basis, only UnitedHealthcare had lower than expected revenue while the other
divisions were in line with projections. The Company continues to see a divergence between growth in
the fee-based and risk-based businesses. UNH continues to post strong growth in fee-based business.
Margin
UNH’s relevant margins are its Medical Loss Ratio (MLR) and operating margin. MLR is relevant
because it captures a company’s ability to price its services and negotiate the costs of medical care. The
pre-tax margin is relevant because it reveals the company’s ability to reduce its SG&A expenses and its
ability to earn investment income, an important revenue source for a managed care company.
UnitedHealth’s MLR continued to moderate during 2Q04, contributing to a 70 basis point improvement to
81.8% and benefited from a $60mm prior period favorable development. This is predicated on its current
pricing and cost trends, which show very slight deterioration on both pricing and costs.
Analysts believe that with MLRs at relatively low levels, future operating margin expansion will have to
come from the administrative expense side in addition to cost synergy opportunities from the recent Mid
Atlantic Medical acquisition, and the pending OHP acquisition. The administrative expense will have to be
met with productivity gains from United Health’s investments in information technology enhancements
and service capabilities.
According to Bear Stearns, management’s focus on diversifying operations to take advantage of
opportunities beyond managed care has been a driver of the Company’s excellent financial performance,
which should continue through 2004 and beyond.
Earnings Per Share
EPS has grown at a 39.3% annual rate over the past three years and at just over 38.7% for the past five
years. EPS for FY ’03 came in at $2.96; growth for FY ’03 versus FY ’02 was an impressive 39.0%. The
Company reported EPS of $0.93 in the current quarter, which was above the consensus estimate of
$0.92.
Actual EPS results have exceeded consensus estimates for at least the past five quarters. The
consistent results speak to the visibility and steadiness of Management’s business model. The
consistent growth rate in EPS also speaks of Management’s discipline in maintaining predictable results,
a difficult feat in any industry.
Fiscal year ended
2Q 2004 (A)
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3Q 2004 (E)
4Q 2004 (E)
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1Q 2005 (E)
2Q 2005 (E)
3Q 2005 (E)
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04 Dec.
Zacks Consensus
Average EPS
Digest average EPS
Digest High EPS
Digest Low EPS
Management
guidance
$0.93
$0.98
$1.04
$0.93
$0.98
$1.00
$0.97
$1.03
$1.09
$1.00
$1.05
$1.09
$1.03
$1.10
$1.15
$1.07
$1.16
$1.24
$1.12
Target Price/Valuation
Bullish analysts believe that UNH deserves a premium valuation in comparison to its peers and that
growth prospects continue to be very robust. Though not surprising in sell-side research, it is worth
noting that 82% of analysts covering the Company are positively biased on the stock. The remaining
18% are neutrally-stanced.
The average price target for analysts providing such a number is $76.50. The price target ranges from
$71.00 (Morgan Stanley) to $86 (Smith Barney). Clearly, even neutrally-stanced analysts expect
significant upside from where the stock is currently trading. Refer to the accompanying spreadsheet for
individual analyst details.
UNH, at $65.50, trades at 17.13 FY ’03 EPS. Based on consensus FY ’05, the forward P/E is 14.54x.
Taking into consideration long-term expected growth in EPS, the Company’s forward P/E to long-term
growth ratio (PEG) is 0.76. A PEG under 1 is generally considered favorable. However, the individual
must determine his/her conviction in the expected long-term growth rate. UNH could support a higher
PEG ratio due to the consistency of its results over the past five years and the robustness of expected
long-term results.
Metrics detailing Management Effectiveness are as follows:
Metric
Value
Return on Assets (ROA) (ttm)
11.95%
Return on Equity (ROE) (ttm)
37.68%
Return on Invested Capital (ROIC) (ttm)
24.71%
Return on equity is extremely high. ROIC is lower but also very favorable as it is almost 2x the 10.36%
average for the S&P500. UNH is a uniquely profitable company that has performed at a high level for
quite some time.
Long-Term Growth
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Sixteen analysts have published a 3-5 year EPS growth rate. The average long-term growth rate is
17.5%. Management has targeted a long-term EPS growth rate of 30%. So analysts as a whole are
slightly less optimistic than management.
The areas in which UNH needs to perform in order to achieve its long-term growth objectives are: (1)
maintaining its MLR, which implies keeping its medical care revenue and costs in check and growing in
tandem; (2) continued overall membership growth which ensures market share growth follows; (3)
continual improvements of technology which reduce G&A expenses; (4) an aggressive share buyback
program.
Analysts expect UNH management to continue share repurchases due to significant amounts of free
cash flow and low levels of indebtedness.
Individual Analyst Opinions
Given below is relevant information from the most recent reports on UNH from the analysts currently
covering the Company. Please refer to the accompanying spreadsheet for specifics on individual income
statement projections (including sales and EPS), recent revisions to estimates, and justifications for price
targets provided.
POSITIVE RATINGS
Advest – Stock is rated Buy with $75 price target
The analyst believes that the quarter once again featured significant administrative improvement.
According to him, United's focus on administrative efficiency is bearing fruit, and he believes the gains to
be sustainable.
Banc of America – Stock is rated Buy with $73 price target
According to the analyst, UNH's outlook following its second quarter earnings report continues to look
strong, although its emphasis is clearly not enrollment growth. UNH's substantial market shares afford it
some cost advantage in the risk business, but its interest in enhancing it is not obvious. Its corporate
success is likely to turn mostly on its large, national account business.
Bear Stearns – Stock is rated Outperform with $75 price target
The analyst believe that the company’s premium valuation to the group reflects 1) the company’s
relatively more broad-based product offerings and focus on diverse fee-based services and 2)
increasingly differentiated service capabilities, an aspect not lost upon employers.
CSFB – Stock is rated Outperform with $80 price target
The analyst believes that the stocks in the sector should perform well over the next several months. He
also believe the 30% premium at which UNH trades relative to the group will diminish over time, which
means that he expects the strongest relative performance from some of the company’s peers - most
notably Aetna
J.P. Morgan – Stock is rated Overweight with no price target
Given United’s diverse revenue streams, strong growth prospects, cash flow generation, and superior
returns, he believes UNH shares should continue to trade at a substantial premium to the group average,
and hence he reiterates his Overweight rating.
Legg Mason – Stock is rated Buy with $75 price target
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According to the analyst, United is a health services company that facilitates health care delivery,
financing, and medical information flow to many constituents. He clubs the company with the ones that
drive managed care stock prices up and down annually. He believes that United has been able to
effectively increase prices and maintain a positive spread above moderating medical cost rends.
Lehman – Stock is rated Overweight with $76 price target
UnitedHealth led off the earnings season for the managed care industry with a strong earnings report.
The analyst views the strong performance in the current quarter as a further confirmation of the projected
operating expectations and expects an improved financial positioning.
Merrill – Stock is rated Buy with $75 price target
The analyst continues to believe that investors should focus on quality names such as UNH, given the
diversity of its business across different business lines as well as his belief that the company will forego
enrollment if it isn’t priced right. According to him, the primary risk/challenge for UNH is to keep delivering
on the high expectations of investors, driven by the company’s strong past performance and
management’s optimistic assessment of the company’s future.
Morgan Stanley – Stock is Overweight with $71 price target.
The analyst believes that UNH will continue to benefit from a diversified portfolio, a solid balance sheet
and the trend towards self-insuring among employers.
Piper Jaffray - Stock is rated Outperform with $82 price target
While the analyst see UNH as the clear market leader across the healthcare benefits market, he view the
Company as a relative "change agent" that is driving the transformation of this industry from a reactive,
manual-based business to a proactive, information-driven self service model.
Prudential – Stock is rated Overweight with $80 price target
The analyst believes that UNH's earnings outlook will ease investor concerns over the managed care
industry’s growth prospects. UNH provided an outlook where pricing discipline predominated, medical
cost trend moderation continued, SGA expense reduction accelerated, and enrollment growth
rebounded. He believe UNH will experience substantial earnings growth driven not only by its keen focus
on self-funded health plans and healthcare services, but also its underwriting expertise.
Raymond James – Stock is rated Outperform with $73.00 price target
The analyst believes that rekindled fear regarding the commercial underwriting cycle contributed to softer
than expected enrollment. The analyst highlights that UNH’s diversified operations translates to a lower
level of exposure than its peer group while the company’s industry leading technology initiatives that offer
revenue and margin expansion opportunity.
Smith Barney Citigroup – Stock is rated Buy with $86 price target
The analysts view United as the bellwether stock and expect United to outperform the general market
over the long run. The analyst remains bullish on United Health because he expects an EPS growth 2-3
times faster than the overall market, yet his analysis shows that United Health and the group trade at a
discount to the market.
UBS – Stock is rated Buy with $79 price target
The analyst expects UNH to trade at a premium to the group given its superior growth prospects. He
views these results as very strong, and believes it confirm his views of the robust fundamental outlook for
UNH and the group.
Wachovia – Stock is rated Outperform with $74-78 price target
The analyst believe UNH's earnings outperformance will continue over the next several years driven by
above-average enrollment growth and operating margin improvement. UNH's leadership position in
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technology and business process improvement coupled with a diversified revenue stream gives it
strategic advantage over its peers. He views the equity as a core health care holding.
Williams Capital - Stock is rated Strong Buy with $79 price target
United’s investments in technology and streamlining operations are paying off and the analyst expect this
trend to continue for the rest of 2004 and 2005 and contribute to margin expansion. UnitedHealth Group
remains his top pick in the managed care sector due to its diversified portfolio and superior operating
efficiencies.
NEUTRAL RATINGS
Bernstein – Stock is rated Market Perform with $68 price target
The analyst remain very cautious on the managed care sector, and expect subsequent quarters to show
rapid fundamental deterioration across the sector with slower growth for all but the few with meaningful
SG&A opportunities. The tougher competitive landscape is now evident in the proliferation of not-for-profit
Blue plans deliberately pricing below expected cost trend in an effort to bring down their now high
margins, which ultimately disrupts pricing and growth for the entire managed care sector given the
relatively fixed size member market.
CIBC – Stock is rated Sector Perform with no price target
The analyst believes that UNH continues to perform well and the stock is fairly valued,with nearly equal
upside potential versus downside risk.
Fulcrum – Stock is rated Buy with $83 price target
The analyst believes that better than expected operating expense leverage is in part due to the
company’s continuing investment in technology, productivity improvements and process optimization, but
also believes that the “use” of admin cost savings to achieve operating earnings is sometimes a sign of
the late stages of the “premium cycle.” He further expects the shares to be affected by investor
perceptions about 2004 premiums and cost trends, and the potential for margins to continue to expand in
the health plan business.
NEGATIVE RATINGS
None at this time
NOT RATED
Goldman Sachs – Stock is not rated with no price target
The analyst believes that UNH remains defensively positioned relative to its competitors with its business
diversity and scale & technology leadership. He expects further upside to EPS growth at UNH driven by
new and existing non− traditional health plan products along with synergies from its acquisitions of
Golden Rule (4Q03), Mid−Atlantic (1Q04) and OHP (3Q04E). However, he also flags cautionary signs of
increasing industry competition in UNH health plan enrollments that continue to fall far short of its goals
despite significantly better employment trends 1H04.
SG Cowen – Stock is not rated with no price target
According to the analyst, with the strong Q204 results, UNH has reinforced his view that the diversity of
its platform will enable United to sustain superior growth despite a tough ’04 HMO underwriting
environment. According to the analyst, the stock still has room for significant upside and hence he
recommends purchase of the stock.
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