Market & Earnings - January 21, 2023
Market commentary, portfolio company earnings results, and closer look into UNH
Market
January has been off to a good start, cementing a higher low in December. The S&P 500 has been challenging its 200-day moving average, but was unable to close above it for the week.
In contrast to last year, the technology and consumer discretionary sectors are leading the latest rally. Conservative sectors including consumer staples, utilities, and healthcare are rounding out the bottom.
CPI reports have confirmed inflation is in a downtrend. Coupled with concerns of a slowing economy, yields have come down from their peak from early November. The 10-year yield is down more than 20%.
Yields, however, remain inverted. The 2-year treasuries yield is greater than that of the 10-year. The gap is widening. An inverted yield curve is often considered a harbinger of a recession.
The Fed has stayed firm in their talk of their target reaching or surpassing 5%, and holding it there for a long time. However, with short term yields closer to 4% and dropping, it is clear the bond market is not convinced.
The Fed is expected to raise rates by 25 basis points at the next meeting on February 1st.
The dollar continues to lose strength, dropping almost 11% from the peak. A weaker dollar is a tailwind to companies with sales in foreign currencies, as fixed foreign currency prices convert to more dollars.
Q4 2022 Earnings
Over the last two weeks, one portfolio company reported earnings: UnitedHealth Group.
UnitedHealth Group (UNH)
“UnitedHealth Group Incorporated is a health care and well-being company with a mission to help people live healthier lives and help make the health system work better for everyone.” - 10-K
UnitedHealth Group has two operating platforms: UnitedHealthcare which provides health care benefits (i.e. insurance coverage via employers) and Optum which provides health services (i.e. financial offerings like HSA plans, technology and data solutions for the healthcare industry, and pharmacy services such as network between UnitedHealthcare members and providers).
They break out results into four reportable segments:
UnitedHealthcare, accounting for ~60% of revenue
OptumRX, accounting for ~23% of revenue
OptumHealth, accounting for ~14% of revenue
OptumInsight, accounting for ~3% of revenue
UnitedHealth has been a well-managed business in a complicated, yet defensive industry. Financials are summarized below.
Revenue growth has been consistent on an annual basis. Selling insurance, it seems reasonable UNH is able to grow at least inline with inflation. It is good to see them exceeding inflation growth over.
Gross margins are steady around the 25% mark. This is a lot lower than some other companies we cover, but it is important to consider UNH’s business. The insurance business is essentially about bringing in money today, expecting to pay it out later. There are inherently higher costs of service.
EBITDA margins have been consistent just under 10%.
Working capital has fluctuated, but seems to average consistently around $50 billion.
The company is effective in converting their earnings to FCF, which similarly hovers right under the 10% mark.
FCF return on capital oscillating between 15-24% demonstrates the efficiency of the business
UnitedHealth is well established in the healthcare industry. Insurance and healthcare offerings are resilient, likely maintaining demand throughout even the worse of possible recessions.
Turning to the valuation, UNH seems to be reasonably priced.
A 5.4% yield for a defensive business with a strong moat & growing double-digits seems attractive when compared to a 10Y risk-free rate of 3.5%.
Closing
Healthcare, a defensive industry with strong growth and ongoing potential, is an attractive sector.
UnitedHealth has demonstrated strong fundamentals throughout very turbulent times. UNH was one of the few companies that posted a positive return in 2022, reflecting the market’s confidence in the strength and resilience of the business.
We currently have two other healthcare companies in our portfolio: Intuitive Surgical and Veeva. I also have another two on my watchlist.
Healthcare companies are well positioned to withstand pressure as the market's attention shifts from inflation and rates, to a focus on earnings and understanding the degree of the upcoming recession.
That being said, a risk on shift could lower the attractiveness of defensive companies. January’s rally is a prime example. Growth names have jumped while the more defensive companies have slumped, underscoring the importance of having a well-balanced portfolio.
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Torre Financial is an independent investment advisory firm focused on emerging and established compounders.
Federico Torre
Torre Financial
federico@torrefinancial.com
https://torrefinancial.com
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