UnitedHealth Group (UNH) just got a Christmas gift from Obamacare.
On November 14, in his mea culpa "Yes, you can keep your plan," TV appearance, President Obama told Americans angry about the cancellation of their insurance they could renew individual or small group policies that didn't meet the requirements of Obamacare.
While this decision isn't a plus for most insurers, it's a net positive for UnitedHealth, according to Wedbush Securities. Here's why. While UnitedHealth's competitors were standing in line to get on the glitch-filled healthcareexhange.gov, UnitedHealth decided to side step what has proved to be a huge mess. The payoff for the insurance behemoth is that now they will get their cake and be able to eat it too. Depending on individual state decisions, UnitedHealth should retain many of their former subscribers.
The health insurance sector is about as easy to understand as Stephen Hawking's ideas about singularity and black holes, and Obamacare has made it worse. But various analysts, including Andrew Schenker, are projecting health insurers will get $90 billion in revenue growth from the health care exchanges and Medicaid expansion next year. Quite simply, it's the place for all long term investors to be, and it even presents great opportunities short-term. Despite the already substantial run-up, investors jumping into the right stocks could be looking at a rocket ride, thanks to the impact of the health law.
UnitedHealth is my favorite pick in this space, for a number of reasons that are easy to grasp for a much weaker brain than Stephen Hawking's. (Like mine.) UnitedHealth jumped more than 37% this year and is ranked as one of best Dow Jones' stocks of the year. The run-up was exciting, but just when UnitedHealth investors were starting to celebrate, the stock nosedived. The decline happened on October 17, thanks to reasonable earnings that (nonetheless) didn't please Wall Street. UnitedHealth dropped like a rock with losses of 5% in one day. The stock is so powerful the plunge took down the Dow with it.
A lot of nervous investors and fund managers jumped ship that day. That was a mistake, they should have been buying. The drop turned into a great opportunity. UnitedHealth resumed its vertical trajectory and is up more than 37% this year.
Even as I wrote this article news came out that another short-term dip might be ahead, as UnitedHealth has just become the tenth most heavily shorted Dow stock, replacing Johnson & Johnson (JNJ). Obviously, that means there are a lot of disbelievers.
Considering UnitedHealth's potential for growth, the short interest could generate more gains for the bulls if the short interest grows and the bears need to run for cover. Of course, it's idiotic to buy a stock because of high short interest and hope that the shorts got it wrong. But if UNH is a stock the shorts have targeted as having weak hands, any coming markdown could be a great chance to pick up the stock on the cheap. As negative sentiment builds, a management that is able to avoid disappointment is going to have the shorts rushing to cover their positions.
As it turns out, the market-beating run in health insurance isn't limited to UnitedHealth. The company's four major competitors: Aetna (AET), Cigna (CI) Wellpoint (WLP) and Humana (HUM) have soared. WellPoint has risen more than 50 percent for the same period. Since the first of the year, the share price of Aetna has increased by more than 46 percent. It is much the same story for Cigna, returning a gain of more than 60 percent to its shareholders.
What's going on? The health insurance majors have been a boring sector for decades. Those geared toward the "next big thing" in health care tend to ignore the huge health insurers in favor of the biotechs, as I did in a Seeking Alpha article I wrote last week about Imunogen (IMGN), Celldex (CLDX) and Incyte (INCY).
But with Obamacare transforming one-sixth of the nation's economy, the health insurance sector is no longer strictly the province of boring-but-beautiful, buy-and-hold investors. Sounds great, right? But it also introduces a big risk into this sector that needs to be taken into account.
With the Obamacare rollout off to such a shaky start in 2014, is it time for the big insurers to reverse course? Could the whole health care space implode, along with Obamacare in the near-term future? The major health insurers are now the darlings of high-flying hedge fund managers who dump in and out of stocks without warning. As a private investor, you don't want to wake up before the holidays to find the big guys have pulled out and thrown you under the bus.
One thing is for sure. It's clear now that the beginning of the year was the time to smash open the piggy-banks. Just about everything in health care was on sale then compared to today.
There's still more upside, but the key to not getting burnt is understanding why health insurance stocks prices were bid up and how market forces will interact to continue to create new opportunities in health insurance. No matter what investors think about Obamacare politically--and certainly many don't think much of it--the new health care law has many small investors rolling in money they never thought they'd have. My goal is to help you keep it.
Interestingly, it turns out that the impact of Obamacare on health insurance is fairly predictable. As Galileo Galilei said: All truths are easy to understand once they are discovered; the point is to discover them.
Here's the first truth. In the coming year, success in the health care insurance space is going to be all about management. The stocks you want in this space those whose companies have the smartest guys in the room running them. Next year is going to be extremely dicey, and top management's decisions about how the company will interact with the environment created by Obamacare will take their company higher, or knock it off a cliff. I'll focus later on specifically why I believe UnitedHealth and my second pick, WellPoint have the best managers in place for the avalanche of coming changes.
But let's take a closer look first at how important it is for insurers not to stand pat, but to tear up the old playbook. Obamacare is igniting a firestorm, and insurers who aren't ready for it are going to get burnt to a crisp.
Obamacare's Deal with the Devil
Protecting yourself from a bad ending with insurance stocks requires understanding a few things about Obamacare. Apparently, not many people have succeeded at that, because the confusion surrounding the new health law is stunning.
The most bizarre twist in the whole inept rollout is the total flip-flop in the health law's genuine beneficiaries. How has it turned out that the health insurance companies are the unexpected winners of the Affordable Care Act, and not the consumers who need insurance?
After all, insurers were supposed to be losers under Obamacare. In fact, support for Obamacare was originally based on casting the health insurers as villains. In an appearance at Arcadia University on March 8, 2010, President Obama said:
"Because there's so little competition in the insurance industry, they're okay with people being priced out of the insurance market because, first of all, a lot of folks are going to be stuck, and even if some people drop out, they'll still make more money by raising premiums on customers that they keep. And they will keep on doing this for as long as they can get away with it. This is no secret. They're telling their investors this: We are in the money; we are going to keep on making big profits even though a lot of folks are going to be put under hardship."
Behind the rhetoric is the third truth investors in this space must understand. Most of the attention surrounding Obamacare today focuses on single aspect of the law--what kind of job Obamacare will do at covering the uninsured. But Obamacare is much more about economics than about health. In particular, Obamacare calls for billions of dollars in future government subsidies to help families and individuals buy or expand their insurance.
What does that actually mean? Billions are about to flow from the government (with taxpayers eventually footing the bill) to insurance companies acting as middlemen. The health insurance industry is going to have their fingers so deep in the cookie jar they're virtually looting it.
The coming largesse is so big that's it's been hard for the insurers not to openly gloat about it. As Mark T. Bertolini, the Aetna chief executive, said recently: "We continue to believe that public exchanges represent a longer-term upside opportunity."
David Cordani, Cigna's chief executive, said his company's average annual earnings per share would grow 10 to 13 percent over the next three to five years. Cigna's profits in 2009, which was before any Obamacare provisions kicked in, were $1.3 billion. Next year, analysts are predicting net income of $2 billion.
How does UnitedHealth, my favorite pick about the five majors, expect to fare? UnitedHealth earned $3.8 billion in 2009. The consensus forecast for its 2014 profit? $5.7 billion.
United Health, Strength to Profit From Obamacare
How on earth does UnitedHealth expect to come up with that kind of profit next year? After all, the one big knock on UnitedHealth this year has been low profit margins.
It won't come from membership growth. In terms of membership growth in the United States, UnitedHealth's biggest year is behind it. The company's membership grew by 24% in the first nine months of 2013, thanks to the addition of the military's TRICARE system and its more than 2.9 million members.
TRICARE won't help UnitedHealth's growth in 2014, although the mostly healthy and young new enrollees will help balance things out. And then there's CEO Stephen Hemsley's controversial decision to drop some doctors because of the cuts to the Medicare Advantage program. That could pinch next year--although not a lot, as Medicare Advantage represents only roughly 6.5% of the company's total subscription base.
Here's where the profit is projected to come from. Four months ago, in a move worthy of a Zen-master, Stephen Hemsley threw down a $50 billion wager on the belief that--going forward--he can make a huge impact on rising costs. On July 10, 2013, UnitedHealth announced they were wagering $50 billion on trying to turn the old fee-for-service model of health insurance on its head. Going forward, UnitedHealth is rapidly phasing in an entirely new model--doctors and hospitals will be financially rewarded for patient outcomes. In other words, doctors and hospitals aren't going to be rewarded for treating illness, but for keeping patients healthy.
That's not a passing fancy for health care; it's the wave of the future. Other giant insurers, including Aetna, Cigna, WellPoint and Humana are already linking to accountable care organizations (ACOs). The ACOs reward doctors and hospitals for working together to improve outcomes for patients and to control costs. UnitedHealth is unique in that it has put an actual dollar amount (and a huge one) on how it will pay doctors and hospitals going forward. UnitedHealth has made it clear that any future pay increases to physicians and hospital will be based on improving health outcomes.
Physicians have been resisting the change, but Obamacare gives them no choice. The unsustainable rise in health care costs is a major reason for the unpopular law, and cost-cutting provisions will eventually force the medical profession to accept performance-based programs. These programs rely on encouraging patients to get medical care upfront in a doctor's office, where costs are lower than in a hospital, and use nurses and other caregivers to manage the medical care of populations of patients.
Here's another way UnitedHealth is going to continue to prosper big next year. Last year, while the other majors were trying to decide how to cut up the problematic American insurance pie, United Health headed south of the border, and bought itself a whole new pie.
In 2012, the company bought a huge stake in Amil, Brazil's largest health insurer. UnitedHealth paid 4.9 billion for 90% of Amil. The deal was orchestrated by the owner of Amil, Brazilian Edson Bueno. This former shoeshine boy turned physician, turned self-made billionaire, is now UnitedHealth's largest single investor.
Bueno sits on UnitedHealth's board, and, according to Forbes magazine contributor Ricardo Geromel, now rules UnitedHealth, despite having trouble speaking English.
Edson Bueno is one of those larger-than-life personalities worth studying. He launched a start up in Sao Paulo, Brazil, and with four employees turned it into a business that serves 250, 000 clients. He wrote this (originally in Portuguese) about creativity and innovation.
"I want to spread the belief among the youngsters that to create business ventures is the best thing one can do in his life. Keep a positive attitude. It is not about how many times you fail and fall, but about how fast you pick it up. Have the courage to rise and keep walking. Another thing: Forget about the economy! If reading newspapers makes you down and negative, just stop reading."
UnitedHealth's acquisition startled many observers, but it put the company squarely in the middle of the rapidly growing health market in Brazil, where an expanding middle class is increasingly turning to private coverage. CEO Stephen Hemsley (who would certainly dispute Forbes claim about who now rules UnitedHealth) said in conference call that the Brazilian health insurance market "looks like the U.S. market did 20 or more years ago."
UnitedHealth's staggering buyout of Amil is the highest profile commitment by a U.S. health care firm to foreign operations. But it's also part of a broader trend as U.S. insurers seek faster growing markets overseas. UnitedHealth's decision is to become a major worldwide player in health insurance and thereby greatly reduce its political exposure to any one country.
UnitedHealth's purchase of the Brazilian health insurer in late 2012 is looking better and better. It's extremely unlikely this well-situated insurer is done with foreign acquisitions, which could move it much higher. I like the management combination of former accountant Stephen Hemsley and Brazilian Edson Bueno. Hemsley will steady the ship, while Bueno will keep things interesting. In short, it's a management team that will either cut each other's throats, or propel UnitedHealth much further than it would otherwise go.
Other observers like the pair-up as well. Despite the apparent confusion over who is actually running the company these days, UnitedHealth is considered the best-managed health care stock for 2013 by The Street.
UnitedHealth is a much-hated company, but I confess to having a sneaking fondness for it. I'm not alone in that feeling. Edie Littlefield Sundby, a California woman with stage-4 gallbladder cancer, was insured with UnitedHealth and wrote a powerful Wall Street Journal op-ed about how UnitedHealth kept her on its rolls, despite spending $1.2 million to keep her alive.
Sundby claims she lost her medical insurance--and access to her life-saving oncologist--as a direct result of the Affordable Care Act. The publication of Sundby's story elicited a firestorm, with some arguing that she was a shill for UnitedHealth.
I'm not going to enter into that debate, but I relate to Sundby. I was also insured by UnitedHealth in California when I was diagnosed with cancer. Also like her, I was also not tossed off the plan despite the huge costs of cancer treatment. Finally, I also found my supposed "life-saving oncologist" at Stanford Medical Center--although in my case I'm not so sure the guy actually knew what he was doing.
Stories like this are worth repeating in a financial article because they underline the fact that health insurance isn't just about shareholder value. Worst case scenario, someone who invests unwisely in a health insurance stock stands to lose a portion of their retirement savings. Worst case scenario with unwise governmental policies with health care insurance? You end up not being able to get the health care you need and therefore you don't survive. Obamacare was supposed to end that--let's hope it does.
For investors interested in the wealth-building power of compound interest, United Health currently offers a modest dividend yield of 1.5 %, which is far below the Dow Jones index's average yield of 2.6%. Only four of the other 29 Dow members offer yields lower than this stock.
But the story changes quickly if you look at the dividend increases over the last decade. No other Dow stock has kept up with UnitedHealth in this area--or even come close.
UnitedHealth boosted its payouts by an annual average of 62% over the last decade. UnitedHealth used to sport a token dividend of $0.03 per year, but when the AFC passed, UnitedHealth felt the need to reassure investors. It quickly pumped up the payouts to $0.50 a year in one fell swoop. Moreover, UnitedHealth has headroom for even juicier increases. The company diverted just 17% of its trailing earnings into dividend checks, so the stock seems headed for strong dividend increases in the near term.
WellPoint's Big Bet
Another stock in this space you should have on your radar? It's an unexpected one: WellPoint.
WellPoint presents an interesting alternative to UnitedHealth, because it comes at Obamacare from a completely different angle. While UnitedHealth took a "toe in the water" approach to Obamacare, WellPoint dove in headfirst.
One thing you need to understand before you invest in WellPoint is that this company and Obamacare are now joined at the hip. Of the five majors, WellPoint is the key player in offering benefits to consumers purchasing private coverage on the exchanges, as well as those covered by Medicaid insurance for the poor, which is also greatly expanding under the Affordable Care Act.
On October 23, WellPoint held back on profit forecasts for 2014, citing problems with exchange website that was keeping consumers from signing up. That decision brought the stock down, but I think the new management is being overly cautious about the outlook.
In fact, an overly cautious management is why I'm making WellPoint my second pick among the majors. There is one huge caveat. WellPoint faces a major immediate risk if the Obamacare exchanges don't improve. Medicaid isn't going to carry it alone. While Medicaid is an important growth driver for WellPoint, the program only makes up 12% of the insurer's total membership.
WellPoint's CEO is Joe Swedish, a career hospital executive, who joined WellPoint on February 12 of this year. Swedish is a slow-talking, fly-fisherman with a reputation for integrity and fairness. He's a huge improvement over WellPoint's previous CEO Angela Braly, who played favorites and repeatedly bungled basic operational management.
Wall Street's reception of Swedish was initially lukewarm, but they're warming up to him as he cleans WellPoint's house and fires Braly's old favorites. There's another--and much more important--reason to like him. Swedish's reaction to Obamacare has been to put an entirely new plan in place for WellPoint. Swedish has said he wants the company to leave behind its old model of negotiating discounts and processing claims, and instead play a far more active role helping patients choose health care and helping health care providers coordinate care for patients.
That sounds like pie-in-the-sky, but Swedish might even pull it off. He has 40 years of experience running hospitals full of actual people, instead of the usual insurance executive's background of 40 years of running numbers.
One of Swedish's favorite sayings is: "Culture eats strategy for lunch." In general, he leaves the fancy power plays to his competitors and works at motivating and unifying WellPoint's management and employees. Swedish couldn't be more different from Bueno, and even Hemsley, but he's exactly the right man for WellPoint. He should pull it together and send it to a new level.
Rob Medway, a partner at Royal Capital Management LLC, reduced the firm's position in WellPoint stock when Swedish was hired. He now acknowledges that was a mistake. "WellPoint now has an adult in the room. It's as simple as that," Medway said.
WellPoint has 38,000 workers operating 14 Blue Cross and Blue Shield health insurance plans, spread from California to Maine, all with distinct histories and cultures. I wouldn't hesitate to put my money on a CEO who heads out on his day off with a rod and reel to do a roll cast. Whether in his hobby or in his business life, Swedish is a guy who understands finesse and complexity. That's the perfect manager for a company that has cast its lot with badly troubled Obamacare.
WellPoint also had better-than-expected operating results in the first nine months of 2013, according to Zack. The company was able to retire more than $1.1 billion in debt during the third quarter, which will generate substantial interest savings. The shares currently trade at a 23% discount to the industry average.
More good news? WellPoint's enrollment grew to 35.5 million members, thanks to its acquisition of Medicare insurer Amerigroup. They've raised their earnings guidance three times this year.
But what about Humana? Or Aetna? Or Cigna? In spite of the pandemonium surrounding the barely functional healthcareexchange.gov website and the scare headlines, all the majors are trading within shouting distance of their fifty-two week highs. But unlike Wellpoint and UnitedHealth, Cigna's management has no overall strong strategic direction. Instead, its large foray into non-health insurance has the company chasing its tail. The lack of focus means that of all the major insurers, Cigna is arguably in the weakest position to deal with the radical shifts coming with Obamacare.
Humana underperformed in revenue growth this year, as compared with the industry average of 10.4% . It faces significant headwinds from the ACA's mandates that Medicare Advantage payment rates be reduced--as the majority of its operations are Medicare Advantage related.
Aetna is a much-hyped stock and a favored pick of hedge fund managers. Those who like to try to piggy-back on hedge funds are giving it a lot of press. Unfortunately, hedge fund managers are notorious for bringing down a stock even faster than they pump it up. In addition, Aetna's culture is the most old-fashioned and hierarchical of the five insurers. The company is knocked by many employees in insurance job forums, who feel poor top and middle management and even worse communication is rampant. Aetna is also pricey. Of the five majors, Morningstar rates only UnitedHealth and WellPoint as being at a material discount to their per share fair value.
The Greatest Risk to this Space: Repeal of the ACA
It seems that virtually every other day we hear of another proposed Obamacare "fix."
Senator Mary Landrieu has put forward a bill to force insurance companies to extend cancelled plans for current policies indefinitely. There's also sponsored legislation on the table to allow insurers to sell new policies that don't comply with the health reform law's mandates.
According to Grace-Marie Turner, contributor to Forbes, they're just the tip of the iceberg. Twenty-seven significant changes have already been made to Obamacare, including ten the administration made and 15 passed by Congress and which the president signed into law.
What if the biggest "fix" of all actually occurs. What if the ACA is repealed?
The major insurers all need this law to hold together--particular the individual mandate. If the individual mandate doesn't hold strong, the insurer's sweet deal where the public is legally required to buy their product will evaporate.
How likely is this to happen? As we all know, it isn't easy to end entitlements once they're in place. But things do occasionally blow up, such as the disastrous 1989 Medicare expansion that passed with overwhelming bipartisan support and got rolled back less than 18 months later after Congress was besieged by mobs of angry seniors.
When the November 2014 elections roll around, it will be clear if this law could end up completely dismantled. If that appears likely, the entire health insurance market could destabilize, and those investing in this space are likely to stampede for the exits.
But at least for the time being, the Affordable Care Act is the law of the land. Amidst the sweeping changes are opportunities that haven't been seen in insurance in decades. Make your bets, but don't go to sleep on them. That's the final truth you need to know to succeed in this space, or with any other stock investment. There's no substitute for paying attention.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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