EUR 850.00 For Business Accounts Only

Morningstar | UnitedHealth's 1Q Results Exceed Expectations; Shares Remain Undervalued

First-quarter performance at UnitedHealth Group tracked slightly better than our expectations. However, we don't intend to make many changes to our projections and anticipate our $300 fair value estimate will remain largely unchanged, implying roughly 20 times our estimate of adjusted earnings in 2019. With the market currently valuing the stock below 16 times, we think investors would be well served picking up shares of this wide-moat enterprise.

Consolidated revenue growth continued to impress, up 9.3% versus the prior-year period. Both the Optum segment and the medical benefits business contributed to profitability improvements, with overall operating margin expansion of approximately 70 basis points. The bulk of this improvement stemmed from a medical loss ratio that came in 50 basis points better than we anticipated and lower operating costs largely attributable to the suspension of the health insurer fee for fiscal 2019. Membership growth fell more or less in line with our expectation, albeit with weaker performance from at-risk cohorts offset by a smaller acquisition in the commercial self-insured segment that added approximately 630,000 lives to United's books. Management raised its earnings per share forecast to $14.50-$14.75, in line with our projection of $14.65.

Management suggested that employers and other health plans have provided positive feedback on its decision over the past few months to take the lead in moving its fully insured and self-insured membership to plan designs that provide point-of-sale rebates on branded drug prescriptions. The company does not expect these offerings to have a meaningful impact on the margin structure of its pharmacy benefit manager, as it already passes roughly 98% of negotiated rebates through to the ultimate plan sponsor, whether it be the government, another health plan, or an employer client.

With the pending finalization of the proposed rebate rule expected in the coming weeks, the potential impact on UnitedHealth's product pricing and profitability is top of mind for investors. Management indicated it intends to participate in the demonstration program outlined by the Centers for Medicare & Medicaid Services earlier this month, in which the government will accept bid proposals under the current regulatory regime and offer risk corridors to partially subsidize any cost overruns that result if we see a policy change implemented for the 2020 plan year. The program will run for two years and cover 95% of any cost deviation from target beyond the first 50 basis points. We think this should help reduce any potential variability in plan bids as insurers prepare to submit their proposals in early June.

Separately, management addressed the ongoing public debate around various "Medicare for All" proposals put forward in Washington in recent months. Commentary was consistent with what we'd expect from the country's largest private insurer, but headlines addressing this topic seem to have weighed heavily on stocks throughout the healthcare sector in the past several weeks, with managed-care companies particularly affected. We don't believe the passage of sweeping regulation is at all likely, and we suggest investors take advantage of shorter-term valuation dislocations driven more by shifting sentiment than underlying fundamentals. UnitedHealth fits this description well, with its shares approaching multiyear valuation lows as measured by price/earnings.