UnitedHealth Seems Curiously Undervalued Given Multiple Growth Drivers (NYSE:UNH)

In a business where scale is king UnitedHealth (NYSE:UNH) has all the scale that an investor could ask for and more. What’s more, the company has actively built and pursued attractive growth opportunities outside of its traditional (and more heavily regulated) medical insurance/benefits business, including its OptumHealth provider business, OptumRx PBM, and OptumInsight analytics/information systems businesses.

I like where UnitedHealth sits going into 2023. Normalization of healthcare utilization will be a modest headwind, but the company’s vulnerability to inflation and a potential recession are quite modest, and higher rates benefit the business. On top of that, the company still has opportunities to drive growth from its OptumHealth and Medicare Advantage businesses. While there are some challenges on a straight P/E-based valuation, I do think these shares are undervalued on a longer-term core earnings basis.

Strong Core Earnings Growth, But Closer To Expectations Than Normal

I think the worst that I can fairly say about UnitedHealth’s fourth quarter earnings report was that the company beat expectations by less than what the Street had become accustomed to over at least the last few quarters. Still, core trends were quite healthy.

Revenue rose 12% year over year, a modest miss versus expectations, with 12% growth in the United Healthcare business and more than 16% growth in Optum, the latter coming in just a bit short of expectations on a 4% miss at OptumInsight (up 35% yoy) and a 2% miss at OptumHealth (up 27%), with OptumRx almost 2% ahead (up 8%).

The medical loss ratio (or MLR) improved 90bp to 82.8%, slightly better than expected (10bp), while the SG&A ratio of 15.7% was about 30bp higher than expected and 40bp higher than the prior year.

Earnings from operations rose 24% yoy, beating by a little more than 2%, with United up 38% (a 7.5% beat) and Optum up 16% (a 1% beat). At the EPS line, earnings grew 19% and beat expectations by 3%.

Overall membership grew 2%, modestly better than expected, with no large deviations from expectations. Commercial membership rose slightly (<1%), while Medicare Advantage was strong again at 9.5% growth and Medicaid was up almost 7%.

Little Reason To Expect Growth Issues In 2023

In a year where I expect many companies to see more pressure on growth, I expect UnitedHealth to do quite well for itself.

In the Optum business, an ongoing shift toward outpatient procedures should continue to benefit the business (including its Surgical Care Affiliates ambulatory surgical center business). I also expect ongoing growth in value-based care, particularly with further expansions in the commercial business. Management pointed to a record pipeline for OptumRx, and with Change Healthcare now in hand, management will be working on building a “new and improved” OptumInsight.

Looking at the United side, Medicare Advantage seems well-placed for another year of above-market growth. Medicaid could be a little more volatile as states reinstitute eligibility determinations, but management noted visibility into about 75% of expected 2023 revenue.

Taking a step back, I don’t see all that much macro risk here, and I think that’s a meaningful positive attribute in an environment where sentiment is nervous, if not weakening, regarding the health of the U.S. economy.

Inflation isn’t really much of a threat, and can actually benefit businesses like UnitedHealth. Managed care companies reprice annually, but provider contracts run for about three years, and so that mitigates a lot of the negatives and gives the company good visibility into its unit costs. Hospitals have reportedly been asking for 7% to 15% price increases, but UnitedHealth should have little difficulty passing that on.

A recession, too, doesn’t offer much risk. Commercial is less than 20% of the company’s total enrollment and around 20% of overall premiums and fees. Elevance (ELV) has a little more at risk here (and Centene (CNC) is more leveraged to lower-income customers), but a recession wouldn’t really have a significantly negative impact on UnitedHealth’s business.

Normalizing utilization of healthcare is perhaps a bit more of a threat, but one that I think is already well-understood and factored into guidance. Staffing issues have delayed full normalization for many clinics/hospitals, but utilization isn’t too far off pre-pandemic levels (a few percentage points) and the company has been preparing for utilization to continue to increase.

The Outlook

Over the long term, I expect UnitedHeath’s growth to be driven by ongoing growth in Medicare Advantage enrollment, more cross-selling from OptumRx and OptumInsight, and greater utilization of OptumHealth, as well as increased home-based capitation and expanded value-based arrangements. Management also mentioned during its fall Investor Day that it was looking to build a financial services platform to improve the payment processes between consumers, payers, and providers. Given what a headache this is today, I see this being a potentially meaningful opportunity for the company, though it’s one where a lot of other players have already set their sights (including banks and non-bank fintech companies).

I’m expecting low-double digit core earnings growth from UnitedHealth over the next five years, and double-digit growth over the next 10 years as well, though I expect year-by-year growth to decelerate from the double digits to the high-to-mid single-digits after 2027. Over that time, I also expect an increased payout of excess capital to shareholders, with the payout ratio moving from around 50% into the mid-60%s, and there could be upside there.

Discounting those core earnings, I believe UnitedHealth is undervalued below $600. A P/E-based approach isn’t as straightforward, though. If I use a 19x forward multiple on my 2023 EPS estimate ($25.09, a bit higher than the average), I get a fair value of around $476.50 – a bit below today’s price. Looking back over the last five years, the average forward P/E averaged 18.8x, while over the last 10 years, it averaged 17.2x. I don’t mind paying a premium now, as I think UnitedHealth’s opportunities are as good as they’ve ever been, but “how much” to pay is definitely a fair subject for debate.

The Bottom Line

At worst, UnitedHealth is fairly valued, and I don’t really have a problem owning a great business at a fair price. Given that I think valuation approaches like P/E are limited, I think the undervaluation on long-term discounted core earnings is more relevant (even with the risks of modeling error in later years), and I think these shares are more meaningfully undervalued. Accordingly, while I do see some risk from near-term multiples reverting to the mean, I think these shares are a good candidate for a longer-term holding.