Trade of the Day: UnitedHealth Group (UNH)

Unlike its peers, UNH is not yet overbought

   

Recommendation: Buy UnitedHealth Group (NYSE:UNH) on the breakout under $60 per share.  More conservative investors may consider a buy-write or covered call to protect against downside risk.

Options Alternative: Buy to open the UNH September 60 calls at for $2.75 per share or less.

As investors and analysts wrap their minds – and models – around the impact of the Patient Protection and Affordable Care Act, AKA “Obamacare,” certain healthcare stocks are significantly undervalued. Regulation uncertainty often has that effect on stocks. However, the recent round of upgrades seems to indicate that analysts are starting to catch up to the value within the industry.

We are recommending UnitedHealth Group (NYSE:UNH) right now as one of the firms with the most attractive technical breakouts and the best position to thrive in the age of Obamacare. Unlike Cigna (NYSE:CI) or Centene (NYSE:CNC), UNH isn’t overbought yet.

Technical Outlook

UNH is breaking out of a symmetrical triangle technical pattern. This is a mid-trend interruption that is characterized by converging support and resistance levels that are roughly symmetrical to each other. You can see what this looks like in the chart below. Like most attractive consolidation patterns, the trading bias should be in favor of the prior trend and we can use that to make an early estimate about the potential upside based on the size of the pattern.

2 6 13 unh 1 300x177 Trade of the Day: UnitedHealth Group (UNH)
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Based on the size of the pattern and historical averages, we estimate a short-term target near $74 per share based on the length of the prior bullish leg from December 2011 through June 2012.  “Short-term” for UNH may be six to eight months at a minimum. Option traders should look at an expiration date that accommodates that outlook.

Value Territory

Based on most generally accepted value measures, UNH is trading well below average. Although the PE ratio is problematic, there are times that it stands out, and UNH’s PE is almost 40% below the average for the S&P 500. This is the case even though earnings growth over the next five years is expected to exceed the growth of the last five years. Since the lows of 2009, UNH has grown by over 300%. If growth continues as expected, we should see traders trying to get in front of it throughout early 2013.

The impact of “Obamacare” can’t be overlooked as we evaluate these assumptions. The industry has to deal with risk differently than in the past. Their effectiveness in doing this comes down to two factors:

  • Diversified risk: In the near future, health insurance companies have to raise rates to cover customers who would not have normally been covered in group plans or individually. However, while that may be unavoidable, the health insurance companies with the largest population of insured customers will be more effective at managing that risk. UNH insures the most people within its peer group so we expect its risk to be less concentrated and easier to manage.
  • Large market share: The bargaining power that insurance companies have with providers, hospitals and pharmacies is directly proportional to its market share in the industry. This is another case where UNH has a significant advantage. It is the largest among its peer groups and while it may be disadvantaged in a few local regions, we believe that its national dominance will allow it to focus on costs more effectively than investors expect.

Cause for Concern

Our biggest worry is the fact that UNH declined following the June 2012 Obamacare ruling. It also dropped after the November 2012 presidential election—clear evidence that not everyone is convinced that health insurance companies will be able to navigate the regulatory changes. We believe these concerns are legitimate, but that uncertainty is the source of potential profits. If we are right and value wins the day, then the upside should more than justify the risk.

Recommendation: We recommend UNH on the breakout at prices under $60 per share. Some investors may decide to wait for a potential “throwback” to support near $55.50 a share before buying in, but that may not happen. Active traders may consider a buy-write as an alternative strategy, which means selling a call against the long position to offset risk.

Options Alternative: Buy to open the UNH September 60 calls at for $2.75 per share or less.

John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news.  Get in on the next trade and get 1 free month today by clicking here.


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