Thanks to a rapidly aging Baby Boomer population, there’s little doubt that demand for healthcare services will continue to swell in the years ahead. Over past decade, UnitedHealth (UNH) has steadily increased its presence in this market to take advantage of this growing need. Largely through a series of strategic acquisitions, annual revenues have more than quadrupled since 2000, to an estimated $92 billion this year. Out of the nearly 1,500 health managed care organizations, UnitedHealth ranks first among publicly traded companies in terms of revenues, followed by WellPoint (WLP, $60 billion), and Humana (HUM) and Aetna (AET) (each at around $34 billion) . Other key players in the Value Line coverage universe include Cigna (CI), Coventry Health Care (CVH), and Health Net (HNT).
But while positioning the company to meet the demands of the fastest growing portion of the U.S. population may certainly appear like a “no-brainer” long-term strategic move, the industry has faced a growing number of challenges of late.
To begin with, there’s been an Increasing resistance to premium hikes for some time now. Indeed, healthcare cost advances over the last decade have far outpaced inflation, and businesses have worked to cut costs with less expensive healthcare plans. This has led to intensifying competition among healthcare management companies and hurt enrollment volumes at some providers. Weakened economic conditions have created added pressure, as commercial customer memberships have dropped due to rising unemployment. Also, with lower discretionary income, many households have been forced to cut back or cancel insurance coverage. Meanwhile, medical-cost ratios (expenses paid out versus premiums taken in) have trended up, further eroding margins.
On top of all this, recently enacted healthcare reform has come along to throw another large monkey wrench into the works. The long-term impact of the new legislation remains difficult to quantify at this early stage. For example, on the one hand, newly imposed mandatory insurance requirements will likely bring millions of previously uninsured individuals into the system. Conversely, there’s likely to be increased margin pressure arising from the proposed trimming of Medicare and Medicaid reimbursement payouts, and from new regulations, such as the requirement that even patients with preexisting conditions must be provided coverage.
Reflecting the market’s concerns and uncertainty over profit trends, most of the stocks in this industry are well off their highs of recent years. The group is down about 50%, on average, and UNH has performed in line with this trend, falling 52% from its 2005 peak.
To be sure, the challenges facing the industry can be viewed as positives for some companies, particularly as they could bring about consolidation opportunities. In UnitedHealth’s case, its size and technological efficiency would give it an edge over smaller players.
Due to the large size the company has achieved (and excluding the aforementioned potential transactions), revenue and earnings growth over the coming 3- to 5- year period is likely to be markedly lower than it has been over the past 10 years. As one indication of this decreased growth potential, the company recently initiated a substantial dividend increase. Though still relatively small in terms of yield (1.65%), the move represented a large step after the minor increases of the past decade, and the payout is well above that of its competitors.
In the company’s favor, its Financial Strength rating is solid, with an Above-Average Safety rank (2). Also on the plus side, UNH has maintained an aggressive share repurchase policy, which has cut the number of outstanding shares by more than 20% over the past five years.
Overall, government’s increased role is likely to generally dampen the performance of commercial insurers. But, though the years ahead hold some uncertainties, we like the industry’s strong underlying demand fundamentals. UnitedHealth, we believe, is well positioned because of its size, financial strength, and earnings growth prospects, which gives its stock solid long-term price recovery potential.