UnitedHealth Stock: We See Significant Long-Term Growth (NYSE:UNH)

In late November of last year, I called UnitedHealth (NYSE: UNH) ourTop idea for 2024‘.

While there are a lot of stocks we were bullish on back then, I thought UNH had the highest percentage chance to produce significant profits throughout the year. This was due to the company’s strong operating plan, in addition to – what we saw as – an attractive multiple at just 24 times net income.

Fast forward to today and our thesis did not enough it played as we saw it go. While stock it is In fact, on the upside since our call, it has lagged the S&P 500 this year by about 11%, which is considerable:

Why the underperformance?

In short, there have been a number of difficulties facing the industry that have yet to be resolved, including a slowdown in Medicaid and Medicare spending that has pressured everyone in the industry from UNH to CVS, HUMand others.

While these headwinds are still present in the market, we expect them to ease somewhat as we head into 2025 and beyond. Given that UNH still appears to be a strong relative value by most metrics, we see long-term market-beating potential in this megacap consumer healthcare play.

Today, we’ll explain where we think the stock is headed and why we’re happy to pay a slightly above-market price for this consumer healthcare product.

Does that sound good? Let’s dive in.

Finance UNH

Just to set things straight, if you haven’t read the first article or are unfamiliar with the stock, UNH is a healthcare company focused on health insurance and healthcare facilitation.

The company operates through a number of different divisions, each of which work together to finance and deliver healthcare to millions of Americans:

Currently in the market, the company’s large size and data advantages mean that they can, for the most part, deliver better drugs to their healthcare network, saving costs while trying to improve patient outcomes.

This model has produced excellent resultsespecially as the company has moved more to this value-based model of care.

Over the past several quarters, UNH has been able to beat both the top and bottom lines consistently, and top-line sales per quarter continue to grow in the single digits, although this has slowed somewhat from last year from the beginning of 2024:

This slowdown has been largely behind the underperformance of stocks and is due to several different things.

First of allUNH suffered from a cyber attack that affected Changeone of Optum Insight’s segments:

On February 21, 2024, CHC became aware of the deployment of ransomware on its computer system. Once discovered, CHC quickly took steps to shut down the activity, disconnected and shut down systems to prevent further impact, began an investigation and contacted law enforcement. CHC’s security team worked around the clock with several leading security experts to address the issue and understand what happened. CHC did not identify evidence that this incident extended beyond CHC.

This attack hurt UNH financially (to the tune of approximately $22 million directly and hundreds of millions indirectly), but also damaged the company’s reputation in general. UNH took steps to mitigate the effects of this intrusion, but it turned out to be real negative sentiment for the stock given how much attention was diverted by management to the issue.

Over, industry headwinds remained bullish in 2024, which explains why most healthcare companies have underperformed the market this year.

Many have opinions on this, but a recent article by Yuval Rotem explained the margin issues in the industry well:

As I have discussed at length in my previous articles, five key forces are pressuring the industry: (1) Increasing usage trendshelped by pent-up demand due to COVID-19; (2) Misalignment between CMS rates and stated usage trendwhich presses medical care reports, primarily in Medicare and Medicaid; (3) Medicaid Redeterminationsbecause members joined under the more flexible COVID-19 criteria they lose eligibility; (4) Increasing competitive pressurebecause aggressive pricing and benefits from companies like CVS Health Corporation (CVS) and Humana Inc. (HUM) result in loss of members or lower margins; (5) Regulatory controlespecially on PBMs.

Between rising benefit utilization, declining margin performance, the Medicaid situation and regulatory interest from PBMs, UNH’s business has faced pressure on all fronts.

In particular, increased utilization and weak Medicare Advantage trends are primarily responsible for declining margins:

While management acknowledges that they may have misjudged future outflows given the increased rates of outpatient procedures for seniors, they are confident that they can reign in some of these expenses going forward:

Our medical cost trends primarily relate to changes in unit costs, care activity, and prescription drug costs… We continued to see increased patterns of care, primarily related to procedures in ambulatory for seniors, which could continue in future periods. We strive to mitigate these increases by engaging physicians and consumers with information and helping them make clinically sound choices with the goal of helping them obtain quality, affordable care.

While this will likely result in more claims being denied in the future (which is neither here nor there morally), it will serve to protect the company’s financial viability given the slow growth of Medicaid base rates that put a huge squeeze on UNH’s margins between last year and this year:

Medicare Advantage rate notices over the years have sometimes resulted in base industry rates well below the medical trend ahead of the industry. For example, the final rate notices for 2024 and 2025 resulted in a decrease in the industry base rate, both well below the industry trend for medical cost increases, creating continued pressure on the Medicare Advantage program.

While this all seems like “bad news,” we think margins are near a bottom and should move higher going forward.

Why? Utilization rates are set to fall as weak demand around Covid can finally be completely flushed through the system. Pandemic-delayed procedures and treatment have likely been fully completed at this point, which should help UNH pricing and margin predictability going forward. When combined with a new administration (on both sides) that will likely allocate more resources to benefits, we expect UNH to do better in 2025 and beyond.

So with the headwinds mostly ready to pass, we anticipate that UNH is well positioned to return to positive business momentum over the long term.

It seems the market is already thinking about it, as UNH stock recently hit an all-time high after being stagnant for nearly two years:

All in all, UNH has been under pressure so far in 2024, but we think the company is poised to bounce back as things normalize.

UNH assessment

But how expensive is the company?

Sure, there might be a cyclical low in the company’s margin and growth profile right now, but that doesn’t necessarily mean the stock is a solid buy.

Is the rating over his skis?

In our opinion, no – UNH is attractively priced:

Right now, as you can see, UNH is priced at about 1.4x sales, which is right in the middle of the company’s long-term linear regression deviation bands.

Bottom line, the P/E multiple has “stretched” significantly, but this is largely due to the unevenness surrounding the company’s divestiture in Latin America, which impacted net income but did not materially impact core operations or the profitability of the company.

If you look at EV/EBITDA on a forward basis, which we think is a better measure given the lack of this adjustment in Brazil, UNH trades at just 15x:

It’s true that Seeking Alpha’s Quant system lists UNH as a “D-” on the rating front, but we disagree. In hindsight, a 1.5x PEG for a long-term compound like UNH seems like a no-brainer.

Sure, it’s more expensive than other companies in the space, but the company’s size and operational efficiency are worth the premium, in our opinion.

In a year, we think Fair value because stock should be around somewhere $700 per shareif you get a rebound in margins, continued top line sales growth and a slight increase in the multiple:

If you estimate margins and top-line sales growth that drives annual EBITDA per share growth to about 13% (slightly above the point analysts are looking for), then you’ll end up with FWD TM EBITDAPS of about $43. Apply multiple expansion to 16-17x and arrive at a price target of $700 per share. Again, we avoid using EPS due to the recent distortions surrounding the Latam divestiture and are slightly more bullish on a rebound in earnings due to the factors mentioned in the financial section.

Over the long term, expecting low organic EPS growth in the teens would not be unusual, which leads us to believe that UNH is in a great place for those looking for a short, medium and long-term investment.

There have been better “prices” to get UNH, but even with the recent record high, we believe there is significant upside over the next twelve months of about ~18% – with more to come as the business continues to fade into the second half of the decade.

risks

At the same time, there are some risks to this thesis.

We’re bullish on UNH at this price, but there are reasons why our projections may not pan out as anticipated.

First of allthe Medicare problem may remain a surplus longer than anticipated. Remember – if UNH has to pay more and more for members’ Medicare benefits while government payments remain stagnant, then there’s no doubt that margins can remain under pressure.

In additiongovernment regulation of the PBM industry may impact Optum Rx, which contributes a significant portion of the change to UNH’s top and bottom line. UNH enjoys big economies of scale here, but it’s a potential headwind nonetheless.

finallyif rates not Head into 2025, as the market expects, then there may be no room on the multiple expansion front, and potentially even a multiple contraction downside that isn’t included at all.

Summary

Overall, though, we like UNH as a long-term compound investment. The company’s margins are likely to return to lower leverage following the Covid distortion, and the multiple looks extremely attractive at just 15x FWD EV/EBITDA.

While there are risks that headwinds persist going forward, we are bullish on UNH’s $700 price target over the next 12 months.

Good luck there!