Published by Seeking Alpha Pro
Stocks to Watch in Health Insurance: UnitedHealth, Anthem, Molina
Amid the flurry of M&A activity, these 3 insurers are stand outs for investors.
Published by Motley Fool
Jun 20, 2015 at 2:03PM
Even amidst the uncertainty surrounding the upcoming Supreme Court ruling on Obamacare subsidies, health insurance stocks keep soaring. For example, shares in Cigna Corporation (NYSE:CI) recently spiked 11.7%, when Anthem (NYSE:ANTM) offered to buy it for as much as $175 per share.
The biggest U.S. health insurer by revenue, UnitedHealth Group Inc. (NYSE:UNH) is also seeking to buy a smaller rival. UnitedHealth made a preliminary takeover approach towards competitor Aetna Inc. (NYSE:AET) recently. Meanwhile, Aetna has been attempting to swallow up Humana Inc (NYSE:HUM) by exploring a potential sale.
Admidst all the M&A jockeying, the aforementioned Supreme Court ruling on Obamacare is impending. The high court is expected to rule this summer on King v. Burwell, which could eliminate federal subsidies and make health insurance prohibitively expensive for millions of Americans.
So what’s the scoop? Should health insurance investors be worried, or is this a great time to jump in?
Warren Buffett liked to say that if you’re betting at a card table, and you can’t spot the patsy — you’re the patsy. In other words, there’s a sucker born every minute, but it doesn’t have to be you.
The patsies at the insurance card table right now are those who jump into the sector one month, only to dump out the next. No one has done better in the health insurance sector than buy-and-hold investors. So without further ado, let’s get down to the three insurers with the most catalysts coming that will likely keep moving their share prices higher.
UnitedHealth Group: Determined to become a one-stop shop
UnitedHealth’s CEO Stephen Hemsley isn’t known for his boldness in conference calls. But he steeled his backbone last quarter, advancing guidance to an almost torrid 10% year-over-year pace. Specifically, Hemsley forecast a “$2 billion increase over earlier projections.”
Perhaps in anticipation of a possible coming single-payer healthcare system, UnitedHealth seems intent on becoming a one-stop shop. It just keeps bolting on acquisitions. Most recently, it added to its presence in pharmacy benefit management by acquiring Catamaran. With this new-found scale, watch for UnitedHealth to come out swinging against the high cost of targeted therapies and personalized medicine.
Meanwhile, UnitedHealth is already swinging for the fences with Medicare. A strong Medicare presence is something insurers salivate over, thanks to the increasing profitability of selling Medicare plans and a massive number of aging baby boomers. In fact, Humana’s strong Medicare presence is what likely makes the company an attractive merger target.
But while Humana had 3.1 million Medicare members enrolled (as of March 31), UnitedHealth had 3.4 million members at the end of last quarter. That puts Humana second to UnitedHealth, who should remain the nation’s largest Medicare provider for the near future.
UnitedHealth also has a fast-growing, high-margin data analytics division, known as Optum One. In addition, the company is shareholder-friendly, as evidenced by its repurchase of $4 billion in stock last year and its distribution of $1.4 billion in dividend payments.
Anthem: Bottom line soaring, security breach a distant memory
While UnitedHealth is the health insurance leader in revenue, Anthem has a strong role in the individual and small-group markets and is a huge player among national employers. Acquiring Cigna, an insurer with a significant and growing position overseas, would offer even further diversity, although Anthem already has the most diverse membership base among the healthcare insurers, as Dan Caplinger pointed out in Anthem Sees Good Times Ahead as Customers Flood In.
Already, Anthem is successfully squeezing profits from that base. While its first quarter’s revenue grew at a healthy 7% clip, the bottom line was the kicker. Anthem’s net income jumped 23% to $865.2 million. In addition, the company raised net income guidance, forecasting earnings of $9.90 per share for the full 2015 year.
On the downside, a massive cyber breach netted hackers information on 80 million Anthem customers in February. These attacks are never good news, but the company’s response was almost a “textbook case of effective crisis management and preparedness,” according to Andrea Bonime-Blanc, CEO, GEC Risk Advisory.
Hospital system veteran Joseph Swedish, who’s done a terrific job at turning around Anthem since he took over in 2013 as CEO, wrote an apologetic letter to shareholders and customers, explaining the measures the company was taking to deal with damage control.
The health insurer has a cyber-insurance policy that should cover losses up to $100 million, so Anthem’s stock fell only fractionally. But while shareholders clearly forgave the first breach, I suspect they’d be less tolerant if Anthem succumbs to further attacks.
In terms of valuation, Anthem is trading at the lowest P/E (ttm) multiple of the big five insurers. Anthem’s multiple is 16.85, while Aetna clocks in at 19.31, Cigna at 17.74, UnitedHealth at 19.42, and Humana at 27.44. In terms of forecasted earnings, only Aetna’s forward P/E multiple is lower, and then only fractionally, with Aetna at 15.79, and Anthem at 16.20.
If the deal goes through with Cigna, it would vault Anthem closer to UnitedHealth in revenue size. Cigna’s revenue last year totaled $34.9 billion, while Anthem was $73.9 billion. UnitedHealth had revenue of $130.5 billion, including its health-services arm, Optum.
Molina (NYSE:MOH): The master of Medicaid
Medicaid has been Molina’s primary focus for 30 years, so the initial refusal of many states to get on the gravy train of Medicaid expansion was bad news for Molina. (Under the ACA, the federal government pays 100% of the costs for Medicaid expansion through 2016, with the state share gradually increasing to no more than 10%).
But the trend is reversing. Three states have jumped on the Medicaid gravy train in the past nine months. While 21 states are still outside looking in, Medicaid expansion could be coming in Florida, Alaska, and Utah.
As you might expect, Molina is bumping up on the trend reversal. The company saw its annual revenue jump 46% in 2014. The jump attracted so much investor attention Molina’s stock price leapt almost twice that: 88%. Gains have continued this year, with earnings handily beating estimates. Last quarter was particularly stellar. Total revenue surged 53% year-over-year, while medical care costs remained flat year-over-year.
Molina has what might look like a pricey 38.64 P/E (ttm), but that’s below its five-year average of 56.82. In addition, there are other tools in the valuation toolbox. To mention just two of them, Molina’s forward-looking P/E is 25.90, and its Price/Free Cash Flow for the last four quarters is 2.6, vastly superior to the S&P 500 average ratio of 22. Overall, this looks like a company poised to show investors strong returns on the back of Medicaid expansion.
If you’re looking for strong fundamentals and solid earnings growth, take a closer look at these stocks. Molina is the most risky play of the three, but it could also get a nice pop if the consolidation trend continues. While it’s the wallflower at the M&A party right now, that will change rapidly if a buyer appears. But this is hardly a comprehensive guide, so check other Motley Fool articles and investor tools for more guidance.
In the meanwhile, while political uncertainty reigns, and market forces set the stage for what may be a period of rapid consolidation, be careful. Short-term volatility could be just around the corner, but long-term investors know that riding out the bumps can prove to be very profitable indeed.