AET Aetna Inc. (delisted)

We reiterate our Outperform recommendation on UnitedHealth Group Inc.’s (UNH) shares, to reflect our continued favoritism towards the stock as it again beat the fourth quarter earnings estimates. UnitedHealth posted earnings of $1.17 per share, substantially higher than the Zacks Consensus Estimate of $1.02 per share.

Earnings also compared favorably with 94 cents per share reported in the prior-year quarter. The outperformance was driven by strong revenue growth from UnitedHealthcare, as well as from the Optum businesses, partially offset by higher medical cost.

We believe that the insurer will outpace its peers with a significant lead over the near term, given its large diversified business model, expansion into fast growing government business, low medical utilization trends across the sector, growing membership and a solid capital profile.

UnitedHealth managed to perform quite well in 2011, in contrast to analyst predictions that the stock might be under pressure, owing to the challenges posed by the Health Care law and pressure on its government programs like Medicare and Medicaid.

But the Health Care Reform's impact on UnitedHealth’s business model and operating fundamentals turned out to be quite manageable, albeit still subject to some uncertainty. The mandate regarding minimum medical loss ratio (“MLR”) that went into effect at the start of 2011 did not have a major effect on the company’s bottom line.

UnitedHealth was also able to post better-than-expected results throughout 2011, attributable to low medical claim costs, as Americans delayed doctor visits and medical procedures in the face of a weak economy.

In order to position itself for long-term growth, despite the Health Care Reform challenges, UnitedHealth continued to focus on shifting more of its earnings to faster growing and less regulated health-related service (non-insurance) businesses, with the goal of deriving 30%-40% of operating income, up from about 20% currently.

It also continues to focus on its Medicaid/state program business, highlighting the significant upcoming opportunities and capabilities that a diversified carrier could offer to state governments looking to move programs to managed care.

Some of the factors that would boost UnitedHealth earnings in financial year 2012 are:

Medicare, Medicaid Gains: UnitedHealth enjoys a high exposure in the Medicare market, which is expected to boom in the coming years as millions of Americans approach their retirement. Moreover, with the acquisition of XLHealth, the company will further strengthen its position in the Medicare Advantage market, compelling long-term growth.

Fast-growing Health Services segment: This business, branded Optum, boasts of higher margin and is a very important part of the company’s diversification strategy. For the nine months ended September 30, 2011, the segment delivered approximately 18% growth. Now, with the expansion of the health service business, management expects the revenue contribution to approximately double over time.

Strong balance sheet: The insurer enjoys a solid balance sheet with adequate financial flexibility and a favorable debt ratio, which helps it take decisions on acquisitions easily. Moreover, UnitedHealth has opted for shareholder-friendly measures for managing capital such as dividend payment and share buybacks.

UnitedHealth currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. The health insurer competes with other carriers such as Aetna Inc. (AET), CIGNA Corp. (CI), WellPoint Inc. (WLP) and Humana Inc. (HUM).

 
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