2 Undervalued Insurers to Buy, 1 to Avoid
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In an uncertain health and financial market, insurers are selling quite cheaply. However, some actually have too much growth factored in, given the risk. Others have catalysts that are unaccounted for. Still others offer stability.
UnitedHealth Group (NYSE: UNH) is Too Expensive Despite Catalyst
UnitedHealth is one of the prime beneficiaries of the Affordable Care Act, since the law expands Medicaid. The company is still well diversified and comes equipped with a strong balance sheet to gain leverage in any segment. In addition, it has delivered strong operational performance in the past; so, from a defensive standpoint, it is relatively attractive.
The company is also looking to target Latin America, a key emerging market. The company recently purchased 90% of Amil Participacoes, which is a prime Brazilian healthcare company that serves around one fourth of the country's population. This should hedge against any unforeseen downside in greater regulations from the Affordable Care Act. I am further optimistic about the acquisition's founder, billionaire Edson Bueno, joining the board. This suggests a focus on international healthcare and not just US healthcare.
On the other hand, much of this has already been factored into the stock price. Rebate obligations, combined with greater utilization rates, will also cause margins to shrink. Analysts forecast the company's EPS only growing by around 4% and 14% in the next two years. At a 13x multiple, this translates to not nearly enough upside at a 10% discount rate to justify making an investment.
Since UnitedHealth is quite expensive, I recommend going with Cigna and WellPoint for diversification. The latter is cheap at around 8.5x past earnings, despite forecasts for 10.1% annual EPS growth over the next five years. Like United Health, WellPoint is also well positioned in the, frankly, unsustainable Medicare and Medicaid growth (I wouldn't worry about this unsustainability, however, until at least five years out from now).
The insurer was able to penetrate these government programs through buying out Amerigroup for $4.9 billion. Large generation of cash flow, combined with fiscal conservatism in capex, has enabled the company to become a free cash flow engine for accretive takeover activity. Shares are now at a discount to book value, so the free cash flow can also be used to substantially boost EPS through stock buybacks.
Cigna has similarly scaled up through the buyout of Health Spring. The revenue and cost synergies of this takeover has yet to be realized, but they are coming off of good momentum from the last few quarters. Double-digit consolidated operating growth is, for example, a testament to management's strong ability to weather difficult macro periods. Accordingly, I recommend buying for the stability.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of UnitedHealth Group and 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.