UnitedHealth Group: A Blue-Chip…

Huge Stack of Cash

Huge Stack of Cash

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The draw to dividend growth investing is the potential to make your money work harder for you than you ever could. After all, investments don’t sleep, take a vacation, or get distracted.

And this argument rings especially true if you pick the right dividend growth stocks for your portfolio. One of the larger positions within my portfolio is the giant health insurer UnitedHealth Group (UNH).

Without further ado, let’s go over a few reasons why I like UnitedHealth Group so much and the potential risks facing the stock.

The Dividend Is Still In The Early Innings Of Growth

UnitedHealth Group’s annual dividend growth rate of 18.7% over the last five years is certainly impressive. But is such strong growth sustainable in the years ahead? To answer this question, let’s take both a surface-level look at the stock’s dividend yield compared to its industry and a deeper dive into its dividend payout ratios.

UnitedHealth Group’s 1.24% dividend yield is perfectly in line with the healthcare plan industry average yield of 1.24%, which suggests that the dividend isn’t at any higher risk of being cut than the stock’s industry peers.

UnitedHealth Group is forecasting midpoint adjusted diluted EPS of $18.78 ($18.65 to $18.90) for 2021 against $5.60 in dividends per share paid during that time. This equates to an adjusted diluted EPS payout ratio of just 29.8%.

And if the average analyst forecast for $21.66 in adjusted diluted EPS is any indication, UnitedHealth Group’s dividend looks like it will be just as safe in 2022. Weighed against the $6.40 in dividends per share that I’m expecting to be paid out this year (which assumes a 13.8% dividend raise in June), the payout ratio will remain below 30% at around 29.5%.

UnitedHealth Group’s payout ratios arguably will expand over the long run, which is because the stock’s growth opportunities will gradually decelerate and there will be less reason to retain as much capital for future growth. And with analysts forecasting 14% annual earnings growth over the next five years, I believe that an 8.75% annual dividend growth rate in the long-term is reasonable. Simply put, UnitedHealth Group has tons of potential for dividend growth left in its tank.

A fundamentally sound business

Processing nearly $1 trillion in gross billed charges in 2020 (page 1 of UnitedHealth Group’s most recent 10-K), UnitedHealth Group is the largest health insurer in the world with a $440 billion market cap. The company’s two businesses include Optum and UnitedHealthcare. The former is a technology-driven health services business while the latter offers health insurance to employers, individuals, and governments (info from previous two sentences sourced from pages 1-5 of UnitedHealth Group’s recent 10-K).

UnitedHealth Group condensed consolidated statement of operations

UnitedHealth Group Q3 2021 Earnings Press Release

UnitedHealth Group’s scale as the largest health insurer in the world has allowed the company to keep on winning from a fundamentals standpoint.

UnitedHealth Group’s $213.85 billion in revenue through the first nine months of 2021 grew 11.6% over the year-ago period figure of $191.67 billion (figures according to page 8 of UnitedHealth Group’s Q3 2021 earnings press release). But how did the company pull this off?

Investors need look to no further than UnitedHealth Group adding nearly 2 million members to its customer base since the end of 2020. This was led by growth in the company’s Medicare Advantage and Medicaid plans (data per page 3 of UnitedHealth Group’s Q3 2021 earnings press release).

UnitedHealth Group’s meaningfully higher revenue base and a reduced outstanding share count year-to-date were mostly offset by higher medical claims. For context, medical care was deferred by many hospitals in 2020 in the early days of the COVID-19 pandemic to treat COVID patients. But with vaccines and treatments now in the public health arsenal, more patients are having elective procedures and returning to their doctors in the last twelve months.

UnitedHealth Group’s year-to-date adjusted diluted EPS advanced 1.3% to $14.54, which is satisfactory given the high claims in 2021 that are compensating for lower claims in 2020 (info sourced from page 8 of UnitedHealth Group’s Q3 2021 earnings press release).

UnitedHealth Group’s year-to-date operating results were enough for the company to up its adjusted diluted EPS forecast to a range of $18.65 to $18.90, which at the midpoint would equate to an 11.2% growth rate over the base of $16.88 for 2020 (data according to page 1 of UnitedHealth Group’s Q3 2021 earnings press release and page 1 of UnitedHealth Group’s Q4 2020 earnings press release).

UnitedHealth Group

UnitedHealth Group’s Q3 2021 Earnings Press Release

UnitedHealth Group isn’t just a steadily growing business. What makes the stock a legitimate SWAN pick is its fortress-like balance sheet. What backs up my claim?

According to page 9 of its Q3 2021 earnings press release, UnitedHealth Group’s net debt was $23.09 billion as of the third quarter ($46.97 billion in long-term debt less $23.87 billion in cash and short-term investments). Stacked against the $25.01 billion in earnings before interest, taxes, depreciation, and amortization (EBITDA) that the company generated in the previous four quarters (per page 8 of UnitedHealth Group’s Q3 2021 earnings press release and page 8 of UnitedHealth Group’s Q4 2020 earnings press release), this comes to a net debt to EBITDA ratio of just 0.9.

Based on UnitedHealth Group’s growing sales/earnings and healthy balance sheet, the stock looks like it could be a great long-term investment at the right price.

Risks To Consider:

UnitedHealth Group is likely to continue doing well in the future. But that doesn’t mean the company is without its share of risks. That’s why I’ll be going over a few key risks surrounding the stock as outlined in its most recent 10-K.

The first risk facing UnitedHealth Group is one that all health insurers face, which is from an underwriting perspective (according to pages 16-17 of UnitedHealth Group’s recent 10-K). Because 80% to 85% of the company’s premiums received from customers are used to pay for the health services that are provided to these customers, the company needs to be vigilant with its pricing and forecasts. Even a slight increase in the company’s medical care ratio would have a detrimental impact on its operating and financial results.

Another risk to UnitedHealth Group is the potential for a cyber-attack to result in the compromised sensitive data of customers and proprietary information (pages 18-19 of UnitedHealth Group’s recent 10-K).

While UnitedHealth Group is consistently upgrading its cybersecurity infrastructure, there are no guarantees that the company will stave off every attempted cyber-attack. A major breach of UnitedHealth Group’s IT systems could lead to costly lawsuits for one, which could damage the company’s operating and financial results in the near term. UnitedHealth Group could also suffer tremendous damage to its reputation as a result, which could jeopardize its long-term fundamentals if the cyber breach was on a major scale.

The final risk to UnitedHealth Group is that it operates in a very regulated industry (pages 24-26 of UnitedHealth Group’s recent 10-K). As a result, the company has to dedicate vast amounts of resources to remain compliant with regulations for one. And if UnitedHealth Group is found to not be adhering to any international, federal, state, or local laws, it could face backlash from regulators that could be harmful to its reputation and business results.

Although I have gone over several major risks associated with an investment in UnitedHealth Group, this was by no means an exhaustive discussion of the company’s risks. For a more thorough discussion of UnitedHealth Group’s risk profile, I would encourage readers to check out pages 15-29 of the stock’s most recent 10-K.

A World-Class Stock Trading At A Discount

UnitedHealth Group is one of the highest quality stocks in the world. However, investors must avoid significantly overpaying for the stock to maximize their chances of a successful investment.

For this reason, I will be utilizing two valuation models to appraise UnitedHealth Group’s shares.

The DDM formula

Investopedia

The first valuation model that I’ll use to gauge the fair value of shares of UnitedHealth Group is the dividend discount model, which is made up of three inputs.

The first input into the DDM is the expected dividend per share, which is simply the annualized dividend per share. UnitedHealth Group’s annualized dividend per share is currently $5.60.

The next input for the DDM is the cost of capital equity, which is another term for the annual total return rate that an investor requires on their investments. While this rate typically varies from one investor to another, I prefer 10% annual total returns.

The third input into the DDM is the dividend growth rate annually in the long term.

While the first two inputs into the DDM require little consideration, correctly predicting the long-term DGR requires an investor to weigh multiple variables: These include a stock’s payout ratios (and whether those payout ratios are poised to remain the same, expand, or contract over the long-term), annual earnings growth potential, the state of a stock’s balance sheet, and industry fundamentals.

UnitedHealth Group benefits from a low payout ratio, plenty of future demand for its health insurance offerings, and a nearly flawless balance sheet. That’s why I believe an 8.75% long-term dividend growth rate is justified for the stock.

Plugging these inputs into the DDM, I am left with a fair value of $464.00 a share. This indicates that UnitedHealth Group’s shares are trading at a 0.7% premium to fair value and pose a 0.7% downside from the current price of $467.33 a share (as of January 13, 2022).

Inputs into the discounted cash flow model that suggest UnitedHealth Group is moderately undervalued.

Money Chimp

The second valuation model that I will employ to arrive at a fair value for shares of UnitedHealth Group is the discounted cash flows model, which is comprised of three inputs.

The first input for the DCF model is the last four quarters of adjusted diluted EPS, which is $17.06 in the case of UnitedHealth Group.

The second input into the DCF model is growth assumptions. I’ll be using a 7.5% annual earnings growth rate over the next five years, which is just half of what analysts are predicting. And in the period thereafter, I’ll assume a deceleration in annual earnings growth to 6.5%.

The third input for the DCF model is the discount rate, which is another way of stating the required annual total return rate. I’ll once again be using 10% for this input.

Factoring these assumptions into the DCF model, I come out at a fair value of $542.40 a share. This implies that UnitedHealth Group’s shares are priced at a 13.8% discount to fair value and offer 16.1% capital appreciation from the current share price.

Upon averaging these two fair values together, I compute a fair value of $503.20 a share. This points to shares of UnitedHealth Group trading at a 7.1% discount to fair value and offering a 7.7% upside from the current share price.

Summary: Buy UnitedHealth Group Before Everyone Else Does

UnitedHealth Group has raised its dividend for 12 consecutive years, which makes it a Dividend Contender. And based on its payout ratio that clocks in just under 30%, the stock appears poised to continue this streak for many more years.

This is further supported by the fact that UnitedHealth Group’s year-to-date revenue and adjusted diluted EPS have marched higher, despite higher insurance claims in 2021 resulting from delayed doctor visits and elective procedures due to COVID-19.

UnitedHealth Group’s balance sheet is also built on a solid foundation, which is evidenced by its net debt to EBITDA ratio of just 0.9. Even with the stock up 33% in the past year, UnitedHealth Group looks to be undervalued.

Overall, dividend growth investors would do well to consider snatching up this stock for their portfolio before the discount vanishes into thin air.

Source

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