Investing has been rather rare for me in the last time. Due to several reasons, I have decided to increase my cash reserves. However, sitting on cash doesn’t help me to reach my income goals. And since these goals are challenging, I’m more than happy to be back at the investing side in September. But before going shopping for stocks, I defined a clear goal for my next investments. That goal is to increase the stake in defensive companies to at least 50%. So I kept my eyes open for appealing Consumer Staples, Utilities and Health Care candidates.
Fortunately, I was able to find a company that I believe represents a good long-term investment opportunity. This company is UnitedHealth Group (UNH). Frankly speaking, this company was flying under my radar. It was an article published by Engineering Dividends that captured my interest in the first place. Subsequently, I did some quick research and my interest grew bigger. I took a deeper dive into the financial data and there was really a lot to like about that business. A good opportunity was knocking at the door. All I needed to do was open it. And that’s exactly what I did.
On September 11, I have purchased 6 shares of UnitedHealth Group (UNH) for a total investment of €1,261.55 ($1,388.70). UnitedHealth Group is a new position and the 32nd company in my DGI portfolio.
Because I bought UNH before the next ex-dividend date (September 13), the SF portfolio will receive $1.08 per share on September 24.
UNH – Company Profile
Dividend Yield: 1.9% | 5-yr. Dividend Growth Rate: 26.8% | Most Recent Increase: 20% | FCF Payout Ratio: 24% | Consecutive Dividend Increases: 10 years
Let’s start looking at the company profile. Morningstar comes up with the following business description:
UnitedHealth Group is the largest private health insurance provider in the United States, offering medical benefits to nearly 50 million members across its U.S. and international businesses. As the leader in employer-sponsored, self-directed, and government-backed insurance plans, United has obtained an unrivaled scale compared with its peers in managed care. Along with its insurance assets, United’s continued investment behind its Optum franchises has created a healthcare services colossus that spans everything from medical and pharmaceutical benefits to providing outpatient care and analytics to both affiliated and third-party customers (source: Morningstar.com).
In general, I like the insurance industry. Insurers don’t pay out all the money they collect right away. Rather they will collect money in the form of premiums, invest that money, and then pay out claims as needed at some future date. Experts describe the difference between premiums collected and claims paid as the so-called insurance float. Looking at Buffett’s Berkshire Hathaway, insurance float has been a huge contributor behind the success story of the legendary investor. No wonder Buffett often speaks about such businesses as cash cows.
Meanwhile, UNH is proving Warren Buffett’s view of insurers as cash cows correct. At the end of March, UNH had $12.4 billion in cash and equivalents and $6.3 billion in short-term investments. Thus, UnitedHealth had $18.7 billion in the liquid assets Buffett calls “float.”
Earnings, Revenue, Cash Flow – At a glance
While float might be a good thing, what I value the most is increasing earnings and revenues. They build the foundation for future dividend growth. Think about it. In the end dividend growth will only be sustainable if a company can also grow its earnings over time. That’s common sense.
To begin, let’s have a look at the earnings performance. How well is UNH doing here? Here is a chart by FastGraphs that illustrates the historical EPS results:
Looking at the past 18 years, there has been just one year with declining EPS. Unsurprisingly, it was the year of the financial crises (2008: -16%). All the other years show green light across the board. And folks, it’s not just growth. It’s heavy growth! During the past five years, UNH has increased its earnings per share from $5.50 in 2013 to $12.88 in 2018. This is a CAGR of 18.55%. How impressive is that? And the good thing is that the growth story seems not to be over yet. Looking forward, Morningstar estimates an annual growth rate of 13% through 2023. And as far as 2019 is concerned, UNH is about to beat those estimates. The Q2 results were more than decent, showing growth in every segment. Non-GAAP EPS were up by 14.6%. As a consequence, UNH has slightly increased its full-year guidance for 2019. I like that!
While EPS can be manipulated (through share repurchases for example), Revenue figures are more honest. They unveil a company’s ability to deliver organic growth. No question about it, I like to see increasing revenue streams over time. Having said this, here is UNH’s revenue development from 2013 until 2018:
Over the course of five years, the revenue grew from $121.74 Bil. to $224.87 Bil. That is a compound annual growth rate (CAGR) of 13.06%. Seriously, I can’t remember seeing a comparable revenue CAGR for any other dividend growth company. Here is another interesting fact. UnitedHealth Group is the largest healthcare company in the world by revenue. Additionally, UNH is ranked 6th on the 2019 Fortune 500. So we are looking at a mature business, with a tremendous market capitalization, that is compounding its revenue by a double-digit rate. That doesn’t happen so often. Moreover, Morningstar expects UNH to grow its revenue by 8% annually over the next five years. So chances are high that UNH will defend its position as the world’s largest healthcare company by revenue.
Free Cash Flow
Driven by outstanding revenue and EPS growth, UNH accumulates more than enough Free Cash Flow to easily cover its dividend payments. In 2018, the FCF was sitting at $13.65 Bil., while cash dividends paid amounted to $3.32 Bil. in total. That results in a very low FCF Payout Ratio of 24%. Taking this into account, I wouldn’t be surprised if UNH continues to grow its dividend by double-digit percentages. At least for the foreseeable future, there is enough room to sustain that.
“Quality” is rather an ambitious word. The truth is there is no uniform definition of what quality is. Personally, I like to review some widely used metrics to come up with a picture of the general quality of a business. These quality metrics are offered by some of the best research companies in the world: Value Line, Morningstar, S&P or Simply Safe Dividends. This is what we find when consulting these services for UNH:
UNH scores very well across the board. We see the highest possible grades for Value Line, Morningstar, and Simply Safe Dividends. Overall, the general quality metrics indicate that we are dealing with a high-class business here.
Additionally, it seems that UnitedHealth Group is trading at an appealing price. Morningstar utilizes the discounted cash flow approach to find the fair value estimate. The research powerhouse grades UNH as a four-star stock with a fair value of $310. In other words, MS expects some nice capital appreciation, considering the last closing price of $234.
UNH’s stock is also trading below its own historical valuation. By consulting FastGraphs, we see a normalized PE-Ratio (blue line) of 18.80. The current PE-Ratio is sitting at 16.45. I interrelate these two numbers to each other to come up with the fair value estimate: 16.45/18.80 = 0.875. So UNH seems to be 12.5% undervalued today.
It wouldn’t be fair to speak about all the good things UNH has to offer, without mentioning the risks. The major risk and uncertainty that comes with an investment in UNH, is linked to the political climate in the US. To explain, many politicians are demanding Medicare for All, while others demand the elimination of private health insurance. It’s indeed a very sensitive topic and we can expect this dialogue around healthcare reform to intensify leading into the 2020 election. That’s the risk. Take it or leave it.
However, for those of you who are willing to take some risk, Morningstar points out the following:
[…] we contend that UnitedHealth and its largest peers will find a way to weather the storm. The relatively low likelihood of widespread industry disruption and opportunity for private insurers to continue to be part of the solution suggests to us that UnitedHealth is more likely than not to continue earning excess returns well into the next few decades (source: Morningstar.com).
UnitedHealth Group offers some of the best fundamentals in the entire dividend growth cosmos. Supported by outstanding revenue and EPS performance, we are likely to see strong dividend growth to persist in the future. UNH carries very little debt and its quality grades shine bright when consulting independent gauges such as Value Line or S&P. Wherever you look, there is quality almost everywhere.
Nevertheless, an investment in UNH isn’t free of risk. Political climate change or regulation can be a serious threat for the stock price and the whole business in general. We can’t lose sight of that. However, if you believe that this storm can be weathered, then UNH might be an interesting candidate for your dividend growth portfolio.