4 Reasons to Buy UnitedHealth, 2 Ways to Play

by John Jagerson and Wade Hansen | June 22, 2012 7:30 am

With the Supreme Court ruling on the Patient Protection & Affordable Care Act (often referred to as Obamacare) still looming[1], many investors have been shying away from health care stocks. But they’re missing an incredible opportunity to improve the health of their portfolios.

While the Supreme Court ruling will certainly have an impact on how health care companies conduct business in the future, it will not change the fact that those businesses are going to be profitable ones. The health care sector is poised to be a market leader as the demographic shift in the U.S. pushes more and more baby boomers into Medicare. UnitedHealth Group (NYSE:UNH[2]) is one of the leaders of this pack[3].

Let’s take a look at what UNH has to look forward to in the coming year as it diversifies its revenue streams and looks to maintain its status as the country’s largest health insurer (based on revenue). Each of the following should drive the stock price higher:

Increased Number of Medicare Advantage (MA) Members

UNH has seen the writing on the baby-boomer wall and is making a concerted effort to maintain its lead in the Medicare Advantage (MA) space. MA plans are government-sponsored plans that are offered and administrated by commercial insurers to Medicare beneficiaries. As the baby-boom generation becomes eligible for Medicare, these MA programs are going to be in high demand and will provide a new and lucrative stream of income to the companies managing them.

UNH is a leader in the MA market, with 18.4 % market share. To ensure its dominant position in the space, UNH has acquired both XLHealth Corp and Inspiris — two key providers in the MA market. These acquisitions have been immediately accretive to the company’s top and bottom lines.

New U.S. Defense Department TRICARE Contract

In March 2012, UNH was finally able to crack the lucrative military health care market when it was awarded the TRICARE contract for the Western U.S. TRICARE is the health insurance program that covers both working and retired military-service members and their families. Looking at the Western region, UNH should gain access to approximately 2.9 million eligible beneficiaries.

The contract doesn’t go into effect until April 2013, but investors are already starting to bake the expected profit increase into the stock.

Increased Dividend

UNH showed just how confident it is that it will be able to maintain its high levels of profitability and cash flow when it increased its quarterly dividend by 31% — raising it from $0.1625 per quarter to $0.2125.

Companies are loath to raise dividends unless they are 99.99% sure they can maintain those levels in the future — because nothing looks worse than a company that has to backtrack on its dividend payouts. Lowering dividend payments is a stark signal that a company is struggling, and it’s difficult to put a positive spin on returning less money to shareholders.

So the fact that UNH has increased its dividend not only puts more money back into the pockets of investors but also signals that management is bullish about the company’s short- and long-term prospects.

Continued Share-Repurchase Program

UNH has determined that one of the ways it can return value to shareholders is to buy back shares of UNH stock. The board of directors recently renewed the company’s share-repurchase program, which authorizes the company to buy 110 million shares of UNH stock over time.

This is an extension of the company’s original repurchase program, which was put into place in May 2011 and also authorized the company to repurchase 110 million shares. Fom May 2011 to May 2012, the company repurchased approximately 75 million shares.

This action authorizes the company to buy back approximately 10% of the company’s outstanding shares. If UNH were to fully exercise this option and keep earnings at current levels, earnings per share (EPS), when looked at over the trailing twelve months (TTM), would rise from $4.81 to $5.40.

So at the current price-earnings ratio of 12.5, UNH could be trading as high as $67.50 thanks to this one change, let alone all of the other factors we’ve looked at.

Technicals

Jagerson UNH 300x170 4 Reasons to Buy UnitedHealth, 2 Ways to Play
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From a technical standpoint, UNH is a superstar. Since hitting its lows in March 2009 when the stock market bottomed, UHN has been climbing steadily higher. It has had a few minor pullbacks, but for the most part, UNH has been the envy of stocks everywhere.

UNH recently broke through resistance just below $60 and is poised to move higher. This has been a common theme with UNH. The stock will consolidate for a while before breaking out into new bullish runs.

The analyst consensus for UNH is that it will continue rising up to $67.50 during the next 12 months, with some analysts projecting prices as high as $73.

Conclusion

UNH is the 800-pound gorilla in the health care sector, and it is using its dominance to secure future strength and profitability. As the company continues to diversify its revenue base and effectively return profits to shareholders, investors are going to continue showing their love for this company by buying the stock as it moves higher and higher.

Options Alternatives

If you’re interested in trading options on UNH to take advantage of the continued climb higher, you need to make sure you give yourself plenty of time before expiration. Don’t get caught with a looming expiration date at the same time you’re waiting for a breakout above the neckline. You also need to be aware that call and put values can change dramatically each quarter when the stock goes ex-dividend.

If you want to decrease the amount of money you have to pay up front for the time value you’re buying, you might want to consider entering a bull-call spread with an at-the-money, or slightly out-of-the-money, strike price for the long leg and an out-of-the-money strike price just below or at the target price for the short leg.

Our recommendation for some great profits:

Endnotes:
  1. still looming: http://investorplace.com/2012/06/the-obamacare-ruling-5-investing-scenarios/
  2. UNH: http://studio-5.financialcontent.com/investplace/quote?Symbol=UNH
  3. one of the leaders of this pack: http://investorplace.com/2012/06/3-managed-care-companies-that-could-score-from-obamacare-if/

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