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UnitedHealth Group is an attractive opportunity

UnitedHealth Group is an attractive opportunity

UnitedHealth Group (UNH) represents an attractive investment opportunity, and I expect UNH to deliver 13-15% IRR’s over the next five years. UNH maintains a dominant across the healthcare landscape including: health insurance, pharmacy benefit management (PBM), healthcare delivery, and healthcare data analytics and consulting. UNH’s strong market share has led to improving margins and phenomenal returns on capital over time, and I expect these trends to continue going forward. Management has proved themselves to be excellent capital allocators balancing share repurchases, bolt-on acquisitions, and capex and continues to target 13-16% EPS growth over the long-term, as well as 20+% ROE’s and mid-teens ROIC’s. Despite a market cap of $288 billion, UNH has substantial growth opportunities ahead driven by the aging U.S. population, continued consolidation of provider groups, and global opportunities to grow UNH’s healthcare data, analytics, and consulting platform. The scale of UNH’s growth opportunities are underappreciated, as the total addressable market for its non-insurance businesses is $1.45 trillion globally, with $850 billion in the U.S. and $600 billion abroad.

Furthermore, UNH has played a meaningful role in driving down health care costs through its integrated strategy, combining health insurance, provider groups, a leading PBM, and data and analytics. Finally, the risk of the U.S. adopting a single payer healthcare system is remote in the near to medium term, driven by the gridlocked political environment, the high price tag of a single payer system, and the fact that neither presidential candidate is looking to overhaul the U.S. healthcare system.

UNH Key stats

Company description: UNH is the largest health insurer in the U.S. with roughly 43 million domestic members and 5 million international members. UNH has a top 3 position in each of the major health insurance markets: Commercial, Medicare Advantage, and Medicaid, and health insurance contributes roughly 50% of UNH’s overall earnings. Additionally, UNH’s non-insurance segment, Optum houses three substantial healthcare related businesses: OptumRX (19% of earnings), OptumHealth (17% of earnings) and OptumInsight (13% of earnings).

Dominant market position driving margins and strong ROE’s over time

UNH maintains dominant market positions in health insurance (50% of earnings) and in pharmacy benefit management (19%) of earnings. This has led to improving margins and strong ROE’s over time. Specifically, UNH has increased its operating margin from 6.6% in 2015 to an estimated 8.3% in 2020, and I expect UNH’s operating margin to increase to close to 9% by 2025, driven by the growth of higher margin businesses such as OptumHealth and OptumInsight.

UNH operating margins

As a result of stronger margins, UNH has increased its ROE from 17% in 2015 to 25% in 2019, and I expect UNH to continue generating ROE’s in the 24-25% range through 2025.

UNH ROE

Health Insurance Dominance

UNH is the largest health insurer in the U.S. with roughly 43 million domestic members and an additional 5 million members in South America. UNH has a top 3 position in each of the major health insurance markets: Commercial, Medicare Advantage (MA), and Medicaid, with substantial barriers to entry across these markets driven by economies of scale. Despite being a mature market, health insurers expect to generate 10-13% long-term EPS growth driven by 6-9% topline growth and 4% capital deployment. Topline growth will be driven by a 3-4% increase in enrollment from MA and Medicaid, as well as a 3-5% increase in net premium yield due to overall healthcare inflation.

BAML Health Insurance UNH Membership

Commercial market
UNH has a 15% market share in the Commercial business, #2 behind ANTM with roughly 26mn members. The Commercial market is highly mature and consists of health insurance plans for individuals and group plans offered by employers. Minimal enrollment growth is expected over time, however net premium yields are expected to grow 4-5% per year given strong pricing power for health insurers, with modest margin expansion expected over time.

Medicare Advantage
UNH is the largest player in MA with 5.7 million members and a 24% market share. MA represents a substantial growth opportunity for UNH given the aging U.S. population as 35% of seniors are currently enrolled in MA, but this is expected to increase to 50% by 2030. Seniors consistently rate MA more favorable than the government run FFS despite higher costs, due to the higher level of benefits associated with MA and caps on out of pocket expenses.

Medicare Advantage Growth

Medicaid
UNH ranks #3 in the Medicaid market with 6.4mn members and a 12% market share. 39 states have expanded Medicaid driven by the positive impact Medicaid expansion has on driving healthcare costs lower at the state level. While margins in the Medicaid businesses are lower than MA or Commercial, due to lower reimbursement rates, Medicaid represents a growth opportunity for UNH and should contribute meaningfully to earnings growth.

Medicaid Growth

International
Finally, UNH has an international presence comprised of 5.3 million members in Brazil, Chile, Peru, and Columbia. UNH plans to grow its footprint in these countries, but premiums in these countries are only about 25% of the average premiums across UNH’s domestic insurance business. Additionally, there are limited opportunities to expand to other countries as most developed countries already have government run healthcare systems.

Leading PBM market position

OptumRX is the 3rd largest PBM in the U.S. with 56 million members, 1.3 billion annual prescriptions processed, and a 22% market share. I expect modest revenue growth of 4% per year in this business driven by a 1% increase in scripts and a 3% increase in revenue per script, as the PBM market is highly mature, and market share in heavily concentrated as the top 3 PBM’s have a 70% market share. OptumRX has maintained a 98% customer retention rate over the past few years, but I don’t expect OptumRX to substantially increase its number of customers.

OptumRX

OptumHealth and OptumInsight to drive margin expansion

OptumHealth
OptumHealth serves roughly 98 million individuals through provider groups, digital healthcare, and healthcare banking, with 52,000 physicians employed or contracted by UNH. This business has increased revenue by 23% per year from 2015-2020, driven largely by increased revenue per patient, as well as an increase in the number of patients. Specifically, revenue per patient has increased by 18% per year, from $180 in 2015 to $406 in 2020, driven by an increased number of services provided to patients, through acquisitions and the build out of UNH’s technological capabilities. The number of patients served has grown 4.5% per year from 78 million in 2015 to 98 million in 2020.

Going forward, I expect 10-12% annual revenue growth driven by a 2-3% increase in patients served and an 8-10% increase in revenue per patient. OptumHealth should be able to further increase revenue per patient by acquiring provider groups and other capabilities, given how fragmented healthcare delivery is in the U.S. Additionally, OptumHealth can marginally expand its geographic penetration, although it currently serves roughly 29% of Americans. Management continues to target operating margins in the 8-10% range over time, with operating margins averaging 9.2% per year from 2015-2019.

OptumHealth 

OptumInsight 
OptumInsight provides data, analytics, consulting, and other solutions to customers across the healthcare value chain, including businesses, governments, providers, hospitals, and life science customers. Specifically, OptumInsight serves 4 out of 5 U.S. health plans, 9 out of 10 U.S. hospitals and more than 80 life sciences companies globally. Healthcare IT is a massive market, estimated at $187bn for 2019, and estimated to grow by 15.6% per year from 2020-2026. Growth areas include revenue management, electronic health records, and artificial intelligence to monitor patient outcomes.

At its 2019 Investor Day, UNH cited a survey of 500 leading health care organizations who each plan to spend $40 million over 5 years on AI. representing a $20 billion collective spend. UNH expects OptumInsight to grow revenue by double digits over the next several years, and currently has a $21 billion project back log. Additionally, OptumInsight continues to target 16-20% long-term operating margins well above the average margins of UNH’s other businesses.

OptumInsight

 Financials

UNH Financials

Valuation

UNH currently trades at attractive valuations with a forward P/E of 16.5x and EV/EBITDA of 10.8x. The below chart shows a sensitivity analysis of five-year IRR’s for UNH based on EPS growth for 2021-2025 and the exit P/E multiple in five years. As noted above, management is targeting 13-16% annual EPS growth over the long-term.

IRR Sensitivity Analysis

Single Payer Risk Has Diminished

The key risk for UNH and the health insurance sector is the U.S. switching to a single-payer system eliminating the need for private insurance. Healthcare costs continue increasing as a percent of U.S. GDP, and now makes up roughly 18% of the economy, although the rate of increase has slowed sharply over the past few years. Additionally, 9% of Americans remain uninsured and healthcare outcomes lag other developed countries.

US Health expense as a percent of GDP
Source: CMS.gov

However, this risk has abated for several reasons:

1) President Obama was unable to enact a single payer system during his first term as President despite the Democratic party controlling the Senate and House. Additionally, President Trump was unable to enact meaningful healthcare reform in his first term despite Republican control over the Senate and House. There is a substantial amount of inertia around the current healthcare system, despite its many flaws. Furthermore, the majority of Americans are satisfied with their existing coverage and are not interested in switching to a single payer system.


2) Medicare for All would financially strain Federal and State governments. For example, Bernie Sanders’ campaign estimated that Medicare for All would cost $30 to $40 trillion over 10 years. Other estimates showed the cost in the $32 to $34 trillion range, implying at least $3 trillion per year compared to the 2020 Federal budget of roughly $4.8 trillion.


3) Neither Trump nor Biden have shown any willingness to move towards a Medicare for All type of system. Biden’s recent healthcare proposal involves more government intervention and increased subsidies for individuals but would only marginally impact UNH with some puts and takes. Specifically, Biden’s plans include increasing subsidies for marketplace plans, allowing individuals with employer-based coverage to be eligible for marketplace subsidies, increased support for Medicaid, and lowering the age of eligibility for Medicare age. As a result, I view a Medicare for All as a very remote possibility over the next five years regardless of who wins the 2020 presidential election.


4) Additionally, it would take years to institute a major overhaul of the U.S. healthcare system. The Affordable Care Act (ACA) was signed into law in early 2010, but many provisions of the ACA such as the public health insurance exchanges, and rules for health insurance coverage, did not go into effect until 2014.

Disclaimer
This article is not to be taken as financial advice and is not recommending the purchase or sale of any particular securities. This information is meant merely for informational and discussion purposes only. Please do your own research or seek out a licensed financial professional for help with personal finance and investment decisions.

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