Recent Buy in September 2019

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.

Earnings

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!

Revenue

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:

(Data source: Morningstar.com)

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

(Data source: Morningstar.com)

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 Snapshot

“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.

Valuation Snapshot

(Source: Morningstar.com)

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.

(Source: FastGraphs)

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.

Risk

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).

Summary

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.

 

10 Comments

  1. EngineeringDividends September 13, 2019 at 6:34 am

    Needless to say, I like the purchase, SF.
    I’ve already dipped my toes into the UNH waters twice in the last month, and I’ve got more room to do it again if the price hovers at these levels until I can round up some more cash.
    The quality metrics are very impressive for UNH… they remind me of those for JNJ.
    Looks like another strong stock in the Healthcare sector for your portfolio.
    Thanks much for the mention, too!

    Reply
    1. Snugfortune September 13, 2019 at 10:49 am

      I’ve been increasing the Healthcare share throughout the year. Purchased AMGN in March, BDX in April and added to JNJ the same month.
      Now, my PF holds five stocks from the Healthcare sector. And I still feel that there is room for more. Especially, I’m looking at Medical Devices.
      ABT and SYK are two interesting stocks from this field. Their dividend yield is low. However, they would be a growth play rather than an income play for me.

      Reply
  2. JC September 18, 2019 at 12:03 am

    UNH looks like a great pick up SF! I have to say it’s been pretty rare to find companies that are growing their top line that much especially in the established business space. That’s pretty freaking amazing. I’ve stayed away from the health insurers mainly because it’s too hard for me to figure out where things are going. I think Medicare for All is coming, the question is just what form. If that happens then will the private insurance marketplace be big enough. Of course UNH definitely seems poised to ride out any potential storms.

    Just noticed your previous comment about SYK and I have to agree with you there. I initiated a starter position and will be patiently waiting for better opportunities to add to my position. I did the same with BDX. Love both of those companies and while their yields are low the growth is fantastic.

    Reply
    1. Snugfortune September 18, 2019 at 10:40 am

      I hear you when it comes to uncertainties linked to the healthcare reform.
      Personally, I knew very little about this issue to be honest. So I’ve read a lot lately, trying to obtain more understanding about it. Heck, I’ve even watched the Dems debate recently:)
      Although I feel more informed now, nobody really knows what is going to happen in the next years. That’s the risk. That’s the reason why UNH’s valuation came down to the level where it is now. The whole issue appears to be very complex and people in the US are divided on that. In such situations, average voters often have a tendency to go with the status quo. I might be completely wrong here, but I think private insurers will be part of the solution. Future will tell.
      Meanwhile, UNH keeps on growing earnings and raising guidance. I like that.

      Congrats on initiating a position in SYK. A fantastic growth company IMO. As mentioned, I would love to own more medical devices in my portfolio.
      So, SYK is high on my list in this regard.

      Thanks for sharing your thoughts, JC!

      Reply
  3. dividendcompounder September 23, 2019 at 7:21 pm

    Wow, this company wasn’t on my radar until now. They have an amazing dividend growth rate and still a low payout ratio. I like to have some large positions in the healthcare sector. I now own ABBV, CVS and JNJ. Businesses I’m interested in are AMGN and MDT, and now also UNH. Thanks for that. 👍

    Reply
    1. Snugfortune September 24, 2019 at 12:34 am

      You’re welcome, DC!
      From the names you’re intrested in, all three offer decent growth prospects.
      Estimated Adjusted Earnings Growth 3-5Y (FastGraphs):
      -AMGN: 7%
      -MDT: 8%
      -UNH: 13%
      A pill company, Medical Devices or Health insurance. Go with something you are comfortable owning and building.
      As mentioned in some other comment, I also like BDX, ABT and SYK in the health care sector.
      Good luck.

      Reply
  4. PassiveCash September 25, 2019 at 8:59 pm

    Awesome write up SF. Loads of information and commentary, appreciate that. You did a great job painting the picture for UNH.
    Congrats on your purchase!

    Reply
    1. Snugfortune September 25, 2019 at 11:58 pm

      Thanks, PC!
      I’m glad you liked it.

      Reply
  5. BrokeInvestor September 27, 2019 at 7:57 pm

    Congrats with a purchase and great summary of the company! You got me very interested and I think it is going to at least make it to my next watchlist, if not my portfolio 🙂
    BI

    Reply
    1. Snugfortune September 29, 2019 at 11:58 pm

      Thanks, BI!
      I see that UNH made it to your watchlist already. So I’m curious whether it will also land in your PF one day 🙂
      Good luck!

      Reply

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