It’s exceedingly difficult to find something to dislike about UnitedHealth Group Inc (NYSE:UNH) stock. In a healthcare sector filled with minefields over the past few years, UnitedHealth stock has tripled over the past four years. Valuation might seem a slight concern, but UNH stock isn’t that expensive on an earnings basis, nor is its balance sheet particularly levered.
UnitedHealth’s fourth-quarter earnings report on Tuesday morning did little to raise any concerns. In fact, it seems to cement the bull case for UNH stock going forward — and assure that the multi-year rally continues. Q4 results blew past analyst estimates: 2018 guidance came in well above Street expectations.
Strategically, the company remains on solid footing. Operationally, margins are expanding, and with growth in the key Optum unit, should continue to do so. Again, there’s a lot to like here — and little to worry about. With UnitedHealth stock still looking fairly valued, if not downright cheap, based on 2018 guidance, there should be more upside to come even after a post-earnings rally.
UNH Earnings Look Strong
Simply from a headline perspective, UnitedHealth’s numbers are solid across the board. For Q4, revenue reached just over $52 billion, up 9.5% year-over-year, more than a point better than analysts projected. Adjusted EPS of $2.59 beat consensus by $0.07.
2018 guidance beat expectations as well. Back in late November, the company issued what was seen as somewhat disappointing initial guidance for this year, targeting revenue of $223-$225 billion and adjusted earnings per share of $10.55-$10.85. The latter figure now has been raised sharply, to $12.30-$12.60 per share.
To be fair, there are a couple of one-time factors in that hike. A little over a week after that initial guidance, the company acquired the medical clinic business from DaVita Inc (NYSE:DVA) for $4.9 billion, which will help 2018 results. In addition, corporate tax reform has lowered UNH’s 2018 tax rate — and boosted its earnings.
Even accounting for those boosts from inorganic factors, the headline numbers look like nothing but good news for UnitedHealth stock. And the 2%+ gain in UNH stock in early-session trading makes some sense. But what’s comforting from a long-term standpoint is that looking closer, the news from Q4 looks just as good.
Bull Case for UNH Stock
Again, healthcare has been a rather difficult sector over the past few years. Managed-care organizations like UNH have dealt with substantial regulatory uncertainty. On the pharmaceutical side, pricing pressure and patent cliffs have led stocks like Valeant Pharmaceuticals Intl Inc (NYSE:VRX) and Teva Pharmaceutical Industries Ltd (ADR) (NYSE:TEVA) to crater.
Pharmacy benefit manager Express Scripts Holding Company (NASDAQ:ESRX) remains more than 10% below 2015 highs even after a recent rally. Pharmacy giants CVS Health Corp (NYSE:CVS) and Walgreens Boots Alliance Inc (NASDAQ:WBA) both hit a 33-month low late last year.
And yet UNH stock has powered higher almost without interruption. There’s two key drivers. The first is the company’s aggressive efforts to diversify. It’s entered Latin America through acquisitions in Brazil and Chile. The DaVita acquisition, as Dana Blankenhorn detailed, gave the company more control over costs. So did the 2015 acquisition of ESRX rival Catamaran.
Rather than simply try to sail through troubled waters, UnitedHealth is aggressively charting its own course. And the steady earnings growth seen in 2017 and 2018 guidance shows the success on that front.
The second, if related, driver is the company’s Optum unit. Optum includes Catamaran, along with the company’s healthcare services businesses — among them IT offerings and data analytics. Optum is a key driver here and it’s carrying its weight. Revenue rose more than 9% in 2017, outpacing the rest of the business. Operating margins expanded 60 basis points to 7.4% — 220 basis points higher than the legacy UnitedHealthcare business.
That’s a big deal for UnitedHealth stock. Optum is becoming a bigger and bigger part of UnitedHealth earnings, driving 44% of segment-level operating profit last year. With higher margins, and what looks like simply a better business, that growth has two effects. It drives overall earnings growth — but it also limits the risk to the legacy managed-care business from government intervention and other factors.
That in turn suggests that earnings should grow — and the earnings multiple assigned to UNH stock should expand at the same time.
UNH Stock Remains a Buy
If that’s indeed the case, UNH remains undervalued even after a big run. It’s not as if the stock is particularly expensive, either. At the midpoint of 2018 guidance, UNH trades at about 18.4x forward EPS. Cash flow guidance suggests a price to free cash flow multiple in the 17x range.
The latter multiple implies little growth. The former figure looks cheap given that Aetna Inc (NYSE:AET) trades at a similar level, despite slower growth. The $207 per share offer made by CVS for Aetna, meanwhile, suggests a 20x multiple — which would value UNH stock around $250, nearly 10% upside.
That level seems a reasonable, if conservative, target for UnitedHealth stock this year. And the Q4 report supports that target.
There are risks here, notably in terms of political and regulatory concerns. But UnitedHealth has managed turbulent markets so far, as seen in Q4. And there’s little reason in Q4 to see that changing any time soon.
As of this writing, Vince Martin has no positions in any securities mentioned.