We are reiterating our Neutral recommendation on the shares of UnitedHealth Group Inc. (UNH), prior to the release of second quarter 2011 results. We anticipate the company’s earnings per share for the second quarter to be 94 cents. The company’s earnings estimate has been revised upward once over the past seven days and thrice over the past thirty days. However, there was no downward adjustment.
UnitedHealth is benefiting from low medical utilization by members, who are postponing or forgoing medical care because of a lingering recessionary mind-set. A low level of medical use has led to increased cash reserves and profitability for the company. Lower-than-expected increases in care use till date has helped contain the company’s costs in the form of lower claims paid. We expect the company to post positive earnings surprises backed by this trend, which is likely to prevail at least till 2011 end as it will take a while for spending to recover from this recession.
UnitedHealth Group is one of the most diversified listed managed care companies. With a broad product and service offering, the company targets the full spectrum of the population. As a result, earnings are buffered to a certain extent against any market dynamics change at the divisional level. This has been witnessed by a growth in the company’s revenues for the past five years. Though the market remains challenging, we expect the company to grow revenues, although at a slower rate. Since its December guidance, the company has increased its revenue expectations four times. The revenue expectation now stands at $101 million, implying an organic growth rate of 7% year over year.
UnitedHealth stands healthy from a balance sheet perspective. The company has maintained its debt-to-capital ratio at favorable levels of 30.8% as of March 31, 2011. For the past five years, its debt ratio stands at an average of 32.1%.
UnitedHealth’s health service business, which comprises of OptumHealth, OptumInsight, and OptumRx, is a very important part of the company’s diversification strategy. Revenues from health services business delivered a 20% year-over-year growth during the first quarter of 2011 and accounted for 14.5% of the company’s operating income. Management intends to expand its health service business to 30%–40% of operating earnings over the longer term; accordingly the company has been making acquisitions in the area. Currently, health services generate about 20% of operating earnings. Management thinks that the company is under-penetrated in the health service area and that investment in this field will reap benefits over the long term.
During May 2011, UnitedHealth raised its annual dividend by 30% to 65 cents, after May 2010 increase of annual dividend per share to 50 cents from a mere 3 cents. This is the highest level of hike currently in the industry. Its annualized 10-year dividend growth rate is 52.2%. Historically, the company had favored share buybacks and mergers over dividend payments for deploying capital.
The company has been generating strong cash flow from operations, which signals strong longer-term cash flow prospects. Further, shareholder’s return will be maximized with regular share repurchases. UnitedHealth spent $620 million in the first quarter of 2011 to buy back 15 million shares, and expects to spend $2–$2.5 billion for repurchasing shares in full-year 2011. The company has approved the repurchase of 110 million shares, which is about 10% of UnitedHealth’s outstanding shares, for about $5.3 billion. The company’s solid capital management is reflected in its return on equity, which has averaged at 18.97% for the past five years.
UnitedHealth is slated to release its second quarter earnings on July 19, 2011, before the opening bell. The stock carries a Zacks Rank # 2, indicating a slight upward pressure on the shares over the near term. Its peers include WellPoint Inc. (WLP), Aetna Inc. (AET), CIGNA Corp. (CI), and Humana Inc. (HUM).
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