UnitedHealth: Cutting Fair Value Estimate as Medicare Advantage and Other Practices Questioned

Key Morningstar Metrics for UnitedHealth Group

• Fair Value Estimate: $473
• Morningstar Rating: ★★★★★
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: High

UNH Stock Update

The Centers for Medicare and Medicaid Services announced plans to increase regulation of the Medicare Advantage market to curb overpayments to private insurers like UnitedHealth UNH.

Why it matters: As the largest Medicare Advantage insurer that may have been more aggressive than peers in risk assessments, UnitedHealth could be subject to a big clawback of overpayments and lower margins in that business.

• The new CMS directive suggests MA overpayments from 2018 to 2024 will be clawed back, which could result in a $20 billion outflow at UnitedHealth, if the Office of Inspector General’s estimates about 2023 overpayments are correct ($3.7 billion) and can be extrapolated to other recent years.
• Also, given recent scrutiny of UnitedHealth’s coverage decisions and the potential for lower MA risk assessments going forward, the growth and margins in UnitedHealth’s medical insurance business may be more constrained than we previously expected.

The bottom line: As a result of the above, we are reducing our fair value estimate on narrow-moat UnitedHealth to $473 per share from $530 previously. Shares still look moderately undervalued to us, although we recognize the high uncertainty around future cash flows in this evolving situation.

• The 11% fair value change is driven more by our reduced near- and long-term expectations for UnitedHealth’s insurance businesses including MA (8%) than by the potential $20 billion clawback in Medicare Advantage-related payments (3%).
• Also, we are lowering our Capital Allocation Rating to Standard, from Exemplary previously, to reflect that management may have been too aggressive with some of its business practices to maximize profits but permanently impaired shareholder value in the process.

Coming up: Republican efforts to cut spending in Medicaid and potentially change the business models of the pharmacy benefit managers could cut into UnitedHealth’s fair value by an additional mid-single-digit percentage by our estimates, if enacted.