How To Play the Insurance Market Under Obamacare

David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Insurers have, as a whole, struggled since the Supreme Court upheld the constitutionality of PPACA. In my view, healthcare and financials are significantly undervalued against future growth prospects. Investors should consider diversifying across a variety of insurers, including UnitedHealth Group (NYSE: UNH), Aetna (NYSE: AET), WellPoint (NYSE: WLP). Below, I review the fundamentals of each.

UnitedHealth

This leading health insurer trades at a respective 10.7x and 9.5x past and forward earnings with a dividend yield of 1.6%. Annual EPS growth of 11.2% is forecasted over the next 5 years. The stock is valued at $54.7B and generated nearly $5B in free cash flow last year, which is a fairly strong yield and allows share buybacks to be particularly accretive.

While the current PE multiple may seem low, it is not by historical standards. The average PE multiple over the past 5 years is 10.4x with the multiple generally rising since mid-2010. On the positive, revenue growth has, as a whole, gone up over the past 5 years. Free cash flow over TTM was $9.5B by 2Q12's end versus $5.7B by 2Q11's and $4.5B by 2Q19's end. This dramatic growth was contributed both through acquisitions and organic activity.

During the second quarter, EPS of $1.27 represented a 9% y-o-y gain as medical costs ran better-than-expected. 3 acquisitions in Medicare have not deterred generous capital allocation plans, which have led to a 31% growth in dividend payments and an extension of the buyback program. Medicaid, which is getting a major expansion from PPACA, has added 210K enrollees to UnitedHealthcare Community & State this year. Better yet, the company only offers Medicaid programs in half of the US and has plenty of more room for penetration.

Aetna

Aetna trades at a respective 7.4x and 6.7x past and forward earnings with a dividend yield of 1.9% and a PEG ratio of 0.68. This last figure reveals that growth has not been fully factored into the stock price. Free cash flow generous is also substantial at one-sixth of the market capitalization. According to FINVIZ.com, analysts put a generous price target of $49.60 on the firm, which provides nearly a 35% margin of safety against downside.

Over the last six months, shareholder value has fallen by 16.7%, and the stock is now much closer to its 52-week low than its 52-week high. During this time, the company has diversified its business through acquiring the Medicare Supplement Business from Genworth Financial, purchasing physician technology solutions from Medicity, and acquiring third-party administrator lines through the Prodigy takeover. By improving vertical integration, Aetna will be able to expand margins through synergistically cutting costs and growing revenues.

Return on assets has been increasing over the years and is around 60 bps above the 5-year historical 4.1% average. Even still, there is room for progress given that the company is at the 66th percentile of the healthcare sector in this metric. From solid growth and momentum to accretive takeover activity, Aetna is well positioned for upside over downside.

WellPoint

The market has similarly failed to fully factor in growth for WellPoint. The stock trades at a respective 7.9x and 7.1x past and forward earning with a PEG ratio of 0.78. The stock is also more than 20% below book value on a 2% dividend yield. Analysts forecast 8.9% annual EPS growth over the next 5 years.

Assuming the company is able to meet growth expectations, 2016 EPS will come out to $8.55. At a 12x multiple, this translates to a future stock value of $102.64. Discounting backwards by a rate of 10% yields a present value of $63.73. This does not provide an exceptional margin of safety, but it still is strong enough based on the bet that multiples will expand as the economy recovers in 5 years.

With the recent introduction of a dividend yield that has steadily risen, management is showcasing confidence over the future streams of free cash flow. Free cash flow over the TTM has, however, been disappointing, By 2Q12's end, the figure was at $2.7B - only $200M more than in 2Q08 and $239M less than in 2Q11. Revenue growth has been weak but has recovered to the 3.5%-5.5% territory since 2Q11. Gross margins have been very volatile. While I recommend buying some shares in the company, I would recommend preferentially buying more shares in Aetna and UnitedHealth.


TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of WellPoint. Motley Fool newsletter services recommend UnitedHealth Group and WellPoint. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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