Why UnitedHealth Group Has Been a Top Stock in 2016 So Far

By Motley Fool StaffMarketsFool.com

Investors came into 2016 nervous that Obamacare losses would derail UnitedHealth Group's (NYSE: UNH) profitability, but improving profitability for UnitedHealth's other businesses and Donald Trump's anti-Obamacare platform has investors exiting the year far more optimistic.

An improving outlook has made UnitedHealth's shares one of the best performing big-cap healthcare stocks in 2016. Can the company's good fortune carry over into 2017? In this clip from The Motley Fool's Industry Focus: Healthcarepodcast, analyst Kristine Harjes and guest Todd Campbell discuss UnitedHealth's performance this year and unpack its future opportunity to profit from an Obamacare repeal.

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A full transcript follows the video.

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This podcast was recorded on Nov. 18, 2016.

Kristine Harjes: Todd,are you ready to talk about our third and final stock thathealthcare investors should be thankful for this year?

Todd Campbell:Absolutely, and this one's going to bea little bit different, because we're not talking about two smaller stocks that doubled or more, we'retalking about a giant in healthcare. That company isUnitedHealth Group.

Harjes:Yes. This is the largest health insurer in the United States. It's been steadily climbing higher all year. It's up about 27% from January 1st.

Campbell:Yeah, a huge move, and huge out-performance for a big-cap stock versus the S&P. What's interesting about this company is,similar to the other two companies we talked about,there were a lot of reasons to have some concernsgoing into the beginningof 2016 with UnitedHealthcare. They had just come out of December saying, "We think we'regoing to lose hundreds of millions of dollars on Obamacare-offered insurance plans this year, and that's going to be a drag on what we think we can deliver n EPS (earnings per share)." Atthe beginning of the year, I think they were forecasting about $7 in earnings this year. Boy, they lowballed that, because theirperformance this year is much better than that. Of course,with the outcome of the election,there are a lot of people thinkingthey could have significant tailwindsif Obamacare is completely rolled back.

Harjes:Right,exactly. Obamacare could bea good thing and a bad thing for this company. We were talking earlier aboutObamacare and how it relates to UnitedHealth, and you mentioned it could be a headwind to their Medicaid segment, but a tailwind to theirindividual market segment. Could you unpack that a little bit?

Campbell:Yeah. Their fastest-growing piece of their business has been the Medicaid part of their business. That's essentially where they run state Medicaid programs. If you go back in the way-backmachine and start thinking about, what did ACA/Obamacare do? One of the things thatObamacare did is allow states to opt into Medicaid expansion. 30+ states chose to decreasethe qualification criteria forMedicaid, allowing millions more peopleto come onto the Medicaid rolls. That hasactually been very profitable for UnitedHealth and many others. That'ssomething we're going to have to walk very carefully as investors, because while on the surface, we may say, "Wow,there's a lot about Obamacare that is a drag onprofitability," there's a health insurance fee that gets charged to health insurance companies for participating in the market place. This year, I think that fee is going to cost UnitedHealth Group about $1.8-1.9 billion. You have the losses that are, theoretically, going to trail off now, from offering those plans in those states. And you also havederegulation that could free them up as far as pricing and how they insure and who they insure, that could provide tailwinds. And then some of that will be offset, potentially, by this Medicaid side of the business.

Harjes:Exactly. Something that isimportant to watch out for with UnitedHealthis called the medical loss ratio. The government mandates thatat least 80% of the premiums that an insurercollects be paid out then forhealthcare costs and qualityimprovement activities. So then you only have 20% of that premium moneyleft over to pay for your administrative, youroverhead, your marketing,all of the things that form your operating cost ratio. Then,after that, that's what you have left as profit. So, as an investor,when you're looking at this company, what you want to see is, that80% is essentially what you're at. Youdon't want to be too far from that 80%. You also want to see youroperating cost ratio be pretty low. On both of these measures,UnitedHealth has done very well,something like 80.3% of their premiums --

Campbell:That'sexactly what it is, Kristine -- 80.3% on the cost ratio. They'recoming right in as low as they can on that.

Harjes:And that's really great for this company. They also have a couple of other really awesome things going for them, for example, their Optumsegment is growing like a weed. This was something that we knew going into 2016, thatthis would be an important business segment. Probablythe most important part of it of all is the PBM, thepharmacy benefitsmanagement part of it, which is called Optum Rx. Back in 2015, there was anacquisition ofCatamaranPBM. We knew that wasgoing to give them some economies of scale. We're starting to see that hit, where the Optumsegment is truly taking off.

Campbell:Yeah. Healthcaredata analytics is a huge area for Optum and a hugepotential growth driver. They deal with so many patients, and they have so many data points that they can leverage to try and figure out how to cut costs out of their system,how to treat patients better, that it should provide tailwinds throughout the industry. Especially since health insurance and health provider costs aren't going lower, they continue to trend higher. So the need for these kind oftechnology innovations stillremains very high for this industry.

Harjes:For me, at least,looking at the three companies we talked about today,UnitedHealth seems like the best buy at them all. It's maybe not as red-hot as the other two are, but it is strong, steady and growing. What do you think?

Campbell:I think, especially if you're an income investor,because it is the only one of the three that actually pays a dividend --

Harjes:It's a soliddiffidence, it's 1.64%, that's on a 32% payout ratio. That's two thumbs up.

Campbell:That's not bad at all, especially for a company whose share price just climbed 30%. That's good, too. So, yes, for income investors,absolutely. If you're a little bit more growth-oriented,you have a little bit longer time horizon, maybe I would leana little bit more toward Exelixis,only because they have a chance to turn profitable next year. I think the estimated loss for next year by analysts is about $0.02. So,there's a chance that if they overdeliverover the next two quarters that they couldactually start to break even next year. Obviously, that could create some excitement there.

Kristine Harjes has no position in any stocks mentioned. Todd Campbell has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Exelixis. The Motley Fool recommends UnitedHealth Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.