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UnitedHealth Group (UNH) Update

UnitedHealth Group (UNH) Update

Since I last wrote up UNH, the stock has slightly outperformed the S&P 500 Index generating a total return of 35% compared to 30% for the S&P 500. The purpose of this update is to provide a deeper dive into UNH’s Optum segment, which will be a key growth driver for UNH going forward. Additionally, this update will discuss the benefits that UNH derives from integrating its health insurance operations with Optum, which provides many unique advantages for UNH relative to its peers. Finally, a quick discussion of UNH’s new CEO and my expectations for strategic capital allocation going forward.

UNH continues to represent an attractive investment opportunity driven by strong expected EPS growth over the next 5+ years, my assessment that an overhaul of the U.S. healthcare system is highly unlikely, and reasonable valuations. UNH maintains a dominant position across the healthcare value chain, operating the largest health insurer in the U.S., the 3rd largest pharmacy benefit manager (PBM), the largest healthcare IT operation, and the largest physician organization in the U.S. UNH has benefited from improving margins and phenomenal returns on capital over time, and these trends should continue going forward driven by the growth of UNH’s higher margin businesses. Management has excelled at allocating capital over time and has strategically built the most integrated company in the healthcare sector. Furthermore, management continues to target long-term EPS growth 13-16%/yr. while generating a 20+% ROE and a mid-teens ROIC’s.

UNH’s substantial growth opportunities are 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. I believe the scale of UNH’s growth opportunities are underappreciated, as UNH noted at its 2020 Investor Day, that the total addressable market for its non-insurance businesses is $1.6 trillion globally, with $950 billion in the U.S. and $650 billion international. 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. Specifically, UNH has focused on value-based care arrangements to incentivize lower health care spending, as well as providing patient care at lower cost of care sites such as outpatient facilities and offering drug rebates at the point of sale.

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 President Biden is focused on incremental changes to the U.S. healthcare system as opposed to wholesale changes. Additionally, U.S. consumer satisfaction with the quality and cost of healthcare is at all-time highs. UNH should generate attractive IRR’s going forward even without any multiple expansion. Specifically, IRR’s over the next five years should be between 18-20%, approximated by UNH’s ~5% earnings yield, and expected EPS growth of 13-15%/yr. going forward.

Company description: UNH is the largest health insurer in the U.S. with roughly 43 million domestic members and 5 million international members. Furthermore, UNH has a top 3 position in each of the major health insurance markets: Commercial, Medicare Advantage, and Medicaid. UNH’s health insurance business, UnitedHealthcare (UHC) has contributed roughly 55% of UNH’s earnings over the past five years. UNH’s non-insurance businesses are housed under the Optum segment and include: OptumRX, which contains the 3rd largest Pharmacy Benefit Manager in the U.S., OptumHealth, which operates the largest Physician organization in the U.S., and OptumInsight, which is the largest healthcare IT company globally.

UnitedHealthcare (UHC)

UNH maintains dominant market share in each of the major health insurance markets in the U.S.: Commercial, Medicare Advantage (MA), and Medicaid. Health insurers benefit from substantial barriers to entry driven by economies of scale and high regulatory hurdles. Despite being a mature market, the health insurance sector expects to grow EPS by 10-13%/yr. driven by 6-9% topline growth and 4% capital deployment, with flat margins. Topline growth for the sector is driven by a 3-4% increase in enrollment primarily from Medicare Advantage and Medicaid, and a 3-5% increase in net premium yield in-line with healthcare inflation.
BAML Health InsuranceI expect UNH’s health insurance business to grow revenue in its UNH segment by 7.5%/yr. driven by 4.5% membership growth and 3% pricing increases. Historically, UnitedHealthcare has growth revenue by 9%/yr. since 2011, with 8% organic revenue growth and 1% from acquisitions.

UNH Membership 6.3.21

Commercial market

UNH has a 15% market share in the Commercial market with roughly 26mn members and ranks 2nd behind ANTM. The Commercial market is highly mature and consists of health insurance plans for individuals and group plans offered by employers. As shown above enrollment growth is expected to be minimal in the commercial market as the market is highly saturated, although there may be incremental opportunities to add to individual membership depending on President Biden’s healthcare proposals going forward. I expect roughly 1% membership growth over time, in addition to 5% pricing given underlying healthcare inflation in the U.S., leading to 6% revenue CAGR going forward.

Medicare Advantage

UNH is the largest player in Medicare Advantage (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 that percentage is forecast 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. As a result, I expect UNH to grow it’s MA membership at 6%/yr. in-line with expected overall growth in MA with 2% pricing increasing leading to 8% revenue growth going forward.

Medicare Advantage Growth

A key growth driver for UNH is its strong plan ratings from the Center for Medicare & Medicaid (CMS) quality ranking system, which is a pay for performance system, with plans rating 4 stars or above (out of 5 stars) receiving quarterly bonuses. For the 2021 Star Ratings Year, 99% of UNH’s entire Group Medicare Advantage membership (HMO + PPO) are in plans rated four stars or higher, with 96% in plans rated 4.5 out of five stars.

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 I expect UNH to grow its Medicaid membership at 6%/yr. with 2% pricing increases leading to 8% revenue growth going forward.

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 are much lower than in the U.S., averaging roughly 25% of the 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. As a result, I expect International to only represent a modest growth driver with 1.5% membership growth and 3% pricing increases leading to 4.5% revenue growth over time.

Optum

UNH’s Optum segment represents the company’s non-insurance businesses. Specifically, Optum houses OptumHealth (providers), OptumInsight (healthcare IT/consulting) and OptumRX (PBM/specialty pharmacy). Optum has accounted for 45% of UNH’s earnings over the past few years but has grown at a much faster rate than UnitedHealthcare historically and should grow at a faster rate going forward. In 2020, OptumHealth accounted for 29% of revenue and 34% of Operating profits, OptumRx accounted for 63% of revenue and 39% of earnings, and OptumInsight accounted for 8% of revenue and 27% of earnings.

Optum stats 6.3.21

Management has guided to double digit revenue growth at Optum over time, albeit with different growth rates and margin outlooks for each business. At its 2020 Investor Day, management laid out a $1.6tn TAM for Optum, with a $950bn opportunity in the U.S. and $650bn internationally. Optum generated $130bn of revenue in 2020, and I estimate at least 95% of that revenue was generated in the U.S. The $950bn U.S. TAM equals 25% of all healthcare spending in the U.S as of 2019 and UNH expects its TAM to grow at a mid-single digit rate over time. In terms of the U.S. opportunity, management highlighted data and analytics, care delivery, behavioral health management, and health financial services. In terms of the international opportunity, UNH expects the market to grow at mid-single digits and highlighted the capabilities of its OptumInsight business.

OptumHealth

OptumHealth serves roughly 98 million individuals through provider groups, digital healthcare, and healthcare banking, and operates the largest collection of provider groups in the U.S. with roughly 56,000 physicians, representing roughly 5% of all physicians in the U.S. The business has a leading market share in numerous lines of business including: the #1 physician organization, #1 HSA, #1 consumer engagement provider (by the # of users), #2 provider of capitated physician services, #2 urgent care company, #3 surgery center company, and #3 behavioral health management provider.

OptumHealth has grown 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. Meanwhile the number of patients served has grown 4.5% per year from 78 million in 2015 to 98 million in 2020.

OptumHealth generates roughly 70% of its revenue from OptumCare, which includes the physician groups, surgical procedure centers, and urgent care centers. The remaining 30% of revenue is generated from a variety of services including behavioral health services, HSA’s, payment processing, telemedicine, consumer engagement through the Rally platform, and post-acute care. Rally is one of the key tools UNH utilizes to positively influence consumer behavior through a user dashboard to help schedule and pay for care, compare costs, join wellness programs, and earn rewards for health behaviors, and is available to roughly 60 million consumers. The segment also includes Optum Bank which manages $13bn through health savings accounts, flexible spending accounts, and health reimbursement accounts.

Going forward, I expect 17% annual revenue growth driven by a 2% increase in patients served and a 15% increase in revenue per patient. OptumHealth should be able to further increase revenue per patient by acquiring provider groups and other capabilities, as well as by converting patients to a capitation model which involves much higher revenues for providers. Additionally, OptumHealth can 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 Stats 6.3.21

OptumInsight

OptumInsight is the largest healthcare IT company in the world generating annual revenue of $11bn, and growing to $14bn once the acquisition of CHNG is completed later in 2021. OptumInsight provides data, analytics, consulting, and other solutions to customers across the healthcare value chain, serving 4 out of 5 U.S. health plans, 9 out of 10 U.S. hospitals and more than 80 life sciences companies globally. Additionally, OptumInsight has a leading market position in all of its major service lines: #1 in Healthcare Technology, #1 in Revenue Cycle Management, #2 in Payment Integrity, #5 in Consulting & Advisory Services, and #3 in Claims Processing.

Over the past decade OptumInsight has growth revenue by 16.5%/yr., and largely organic growth. This has been driven by strong backlog growth averaging 18%/yr. since 2011, with an average book to bill of 1.28, a positive sign for future growth prospects. UNH’s backlog only includes contract revenue spanning the next 5 years.

OptumInsight’s revenue can be categorized across: Managed Services (60% of revenue), Technology (31% of revenue), and Research & Consulting (9% of revenue). Managed Services includes revenue cycle management, which includes billing and collecting cash for patient care, and payment integrity services which includes claims processing and reducing administrative waste (estimated at $260bn for the U.S. healthcare system). OptumInsight managed $70bn of billings in 2020, up from $60bn in 2016. OptumInsight’s Technology business provides clinical insights to improve outcomes and lower patient costs as well as administrative costs, including population health and risk analytics, technology for claims editing, and risk adjustment and payment integrity. Finally, OptumInsight’s Consulting business includes both consulting services and a research arm, to improve operational efficiency, reduce cost of care and improve clinical outcomes.

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 long-term 16-20% operating margin well above margins for UNH’s other businesses, but below OptumInsight’s current 25% operating margin. I am forecasting 10% backlog growth over time, with the higher growth in 2022 attributable to the CHNG acquisition as OptumInsight’s end market are expected to grow 8%/yr., and UNH will likely continue making acquisitions given the tailwinds in this business.

OptumInsight Stats 6.3.21

OptumRx

OptumRX operates a number of pharmacy related businesses including the 3rd largest PBM, 3rd largest Specialty pharmacy, 3rd largest home infusion business, and the 4th largest pharmacy in the U.S.

OptumRX’s PBM is the 3rd largest in the U.S. with 56 million members, 1.3 billion annual prescriptions processed, and a 21% market share behind CVS (32% market share) and CI (24% market share). This business accounts for 50% of OptumRX’s revenue and generates roughly 5% operating margins. The role of a PBM is to manage drug spending on behalf of health plans, self-insured customers, and Medicaid programs. PBM’s offer formulary management (determining which drugs to cover and their cost), use their scale to negotiate rates and rebates with drug companies, and create a pharmacy network as well as negotiate pharmacy pricing. PBM’s also offer mail order delivery, generic drug substitution, claims processing, and helping to improve member adherence.

The next largest business within OptumRX is specialty pharmacy, which accounts for 40% of revenue with roughly 2% operating margins. Specialty phama makes up the fastest growing component of drug spending at 41% of drug spending in the U.S. in 2019 and is expected to reach 50% of spending in 2023. UNH is the 3rd largest player again with a 14% market share, behind CVS (27%), Cigna (20%). Walgreens also a major player with 13% market share.

Finally, OptumRX includes a home infusion business which accounts for roughly 3% of revenue with an estimated 5-10% operating margin, and community and behavioral clinics which account for 7% of revenue and 5-10% operating margins.
OptumRx’s home infusion business ranks 3rd nationally with a 16% market share.

UNH is guiding to 5-8% revenue growth and 3-5% margins going forward with growth driven by an increased number of scripts as well as growing home infusion and community pharmacy. I expect annual organic revenue growth of 5% per year for OptumRX driven by a 1% increase in scripts and a 4% 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 Stats 6.3.21

Benefits of integration

UNH and its members materially benefit from the integrated nature of the company’s various lines of business. Specifically, UHC represents by far Optum’s largest customer at 59% of Optum’s revenue overall. Having such a large captive customer for Optum provides a scale advantage in OptumRX, which allows that business to negotiate higher unit cost discounts with drug manufacturers, which provides a compelling value proposition for members. Bundling health and insurance and PBM services, can also save customers money through bundling.

Additionally, the large customer base provides OptumInsight with much more data than any of its peers, given the number of lives UNH insurers as well as clinical data given UNH’s large ownership of provider groups. UNH’s health insurance offerings also benefit, by leveraging the data and consulting capabilities of OptumInsight, which can allow for more granular policy pricing.

Furthermore, UNH benefits from the shift towards providing value-based care, by moving members (primarily Medicare Advantage) to a global capitation model. Under a capitation model providers are paid a set amount per member per month, regardless of the services received. Providers are incentivized to focus on preventative care, offer care in lower cost sites, and avoid unnecessary procedures, to keep their costs low. Additionally, providers are paid a higher amount per patient per month under the capitation model, boosting physician revenue and profitability. It also allows UNH to capture a larger percent of the economics for each of its members. BAML estimates that UNH generates 5% more earnings per member across its entire membership than a standalone health insurer, as it also keeps the provider economics of OptumCare.

Additionally, UNH benefits from moving members to low-cost sites of care such as physician practices, surgery centers, urgent care, etc., with site of care optimization estimated to save 30-50% in annual spending depending on the site of care. Lower costs for UNH’s insurance business allows UNH to be more competitive in pricing policies, which drives membership growth, leading to increased utilization for OptumHealth and more data for OptumInsight, leading to continual improvements in UNH’s value proposition across its products and services.

Improving margins and strong ROE’s over time

UNH has experienced margin expansion over time through strong growth in OptumHealth and OptumInsight. 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 Margin 6.3.21

As a result of stronger margins, UNH has increased its ROE from 17% in 2015 to 25% in 2019, and I expect UNH’s ROE to approach 27-28% in 2025.

UNH ROE 6.3.21

Capital Allocation & New CEO Priorities

Given the low capital intensity of its business, UNH has generated strong FCF historically. From 2011-2020 UNH generated $118bn of cash from operations and spent $16bn on capex. Additionally, UNH made $52bn of acquisitions, with some of the larger acquisitions highlighted below. Finally, UNH paid out $23bn in dividends, and had net repurchases of $24bn.

Strategically, UNH has been well ahead of its peers in driving consolidation across healthcare services and providers. Some of UNH’s key acquisitions include:

• Catamaran Corp. for $13bn in 2015 to build out its PBM.
• Change Healthcare for $12.8bn in 2021 to expand its healthcare analytics and data capabilities.
• DaVita Medical Group for $4.3bn in 2017 to expand physician practices.
• Equian LLC for $3.2bn in 2019 to improve its payment processing capabilities.
• Surgical Care Associates for $3.2bn in 2017 to build out its surgery centers.

Andrew Witty was recently announced as UNH’s new CEO, replacing David Wichmann who had served as CEO starting in 2017. While the move was unexpected, Witty had been Optum’s CEO and President of UNH. Witty was also the CEO of GSK from 2008-2017.

At a recent investor event, management noted that their top priorities are to emphasize the synergies between UHC and Optum (highlighted above), expand Optum’s reach to 330mn people in the US, and continue investing in technology, data, and analytics. From a capital deployment standpoint, management is focused on adding physician capacity, investments in healthcare data, and expanding its behavioral health capabilities. Additionally, UNH continues to focus on integrating various Optum services to improve the patient experience.

Risks

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

US Health expense as a percent of GDPSource: CMS.gov

However, given President Biden’s modest proposed changes to the U.S. healthcare system, historic inertia around major changes to healthcare, American’s general satisfaction with the cost and quality of their healthcare, and the exorbitant cost of a single-payer system, I believe the risk of a significant overhaul of the U.S. healthcare system is vastly overstated.

Historically it has been challenging to overhaul the U.S. healthcare system given its many complexities, healthcare inertia and prohibitive costs. President Obama had initially campaigned on a single payer system, yet ultimately modified his stance to: "For us to transition completely from an employer-based system of private insurance to a single-payer system could be hugely disruptive, and my attitude has been that we should be able to find a way to create a uniquely American solution to this problem that controls costs but preserves the innovation that is introduced in part with a free-market system." President Obama was unable to enact a single payer system during his first term as President despite a Democratic majority in the House and Senate.

Furthermore, while President Biden’s healthcare proposals announced during his campaign involve increased government intervention and subsidies for individuals but would likely only have a marginal impact on UNH’s health insurance business. 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 highly unlikely over the next four years of Biden’s Presidency.

Additionally, the majority of Americans are satisfied with their existing coverage and are not interested in switching to a single payer system, for fear of losing access to their providers. Americans rate the U.S. healthcare system quite favorably in terms of both quality and cost. A majority of Americas are satisfied with the quality and coverage of the healthcare they receive.

Gallup Poll healthcare quality

Satisfaction is also quite high surprisingly, in regards to healthcare costs, which reached its highest level ever in 2020 per a recent Gallup poll.

Gallup poll healthcare satisfaction

Another impediment to a single payer system is the astronomical cost of such a program, which 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.

Finally, 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. As a result, even if a single payer system was voted into law in the 2025-2028 time frame, it is unlikely to be implemented prior to 2030. As such, UNH would have a substantial amount of time to prepare for such a transition, which I view as extremely unlikely based on the above mitigants I have described.

Valuation

UNH currently trades at attractive valuations with a forward P/E of 22x 2021 consensus EPS and 19x 2022 consensus EPS. I expect UNH to deliver 18-20% IRR’s going forward approximated by UNH’s 5.3% earnings yield and 13-15% annual EPS growth going forward. This represents an attractive opportunity given UNH’s dominance across its major business units and benefiting from secular tailwinds to drive extraordinarily strong growth going forward. Additionally, given the low capital intensity of UNH’s business, the company generates substantial FCF, providing significant financial flexibility to make acquisitions, repurchase shares, etc. Finally, UNH has an excellent track record of generating shareholder value through its strategic capital allocation decisions.

Financials

UNH Financials 6.3.21

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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