EFTA00301317.pdf

J=P= Morgan North America Equity Research 18 June 2014 •, Medicare Advantage Increasing 2014-2017 Med Adv Enrollment Estimates Across the Managed Care Sector With 2015 Medicare Advantage (MA) plan bids submitted earlier this month, we review 2014 open enrollment results through the lens of our proprietary county- by-county benefit database and update our Medicare Advantage model for 2014- 2017. It has become increasingly clear that seniors find the Medicare Advantage value proposition compelling and thus are willing to accept more benefit disruption than was previously appreciated. The 2014 open enrollment period saw MA penetration rates increase broadly across all levels of value-add, including 100+ bps increases at the lowest levels (<$20 benefits PMPM). This was very much a positive surprise vs. our previously conservative estimates and is crucial to our increasingly constructive outlook for MA membership growth over the next several years. Post ow deep-dive on 2014 enrollment results, we take up our 2015-2017 enrollment growth Ifs to 7.2%/8.1%/7.9% from 4.0%/7.1%/7.1% respectively, now reflecting an updated view of lower senior sensitivity to downward changes in Medicare Advantage benefit levels. In addition, we now reflect a modest level of share shift based on plan-specific Star ratings, with HUM expected to again take share in 2015 from UNH/WLP. Overall this analysis provides increased confidence in ow positive MA thesis, and we increase EPS estimates by 3%/7%/1% for 2014-2016 for HUM to $7.80/$9.121$10.43 respectively, as 2014 moves in-line with consensus and 2015-2016 moves ahead of consensus by 3-5%. We reiterate our Overweight rating and $150 price target on HUM. • We are hosting a conference call today at I la ET to discuss our analysis. Dial in is 1-800-857-2942 (US), 1-517.623.4820 (outside US), Passcode: HEALTHCARE. To view ow detailed analysis, see accompanying slides: link. • Increasing our industry Med Adv enrollment estimates. We are increasing our 2015 industry enrollment growth est by 350 bps to 7.2% and our 2016/2017 estimates by --100 bps each to 8.1% and 7.9%, respectively, reflecting greater- than-anticipated senior interest in products with more moderate benefit levels. Our analysis indicates that geographies with average plan benefits less than $20, or 2% better than traditional Medicare, still saw penetration increase of 100+ bps during 2014 OEP, with moderately higher-than-anticipated increases in penetration across all benefit levels. In addition, we updated our estimates for MA rates going forward (-320 bps for the industry in 2015, followed by flat to slightly down in 2015.16). Equity Ratings and Price Targets Company Ticker Mkt Cap If ran) Price ($) Rating Price Target Cur Prey Cur Prey Aetna AET US 29,408.05 80.57 OW at 82.00 81.00 Ogna CI US 24,702.03 90.00 OW ate 95.00 NC Hearth Net HNT US 3,240.12 40.04 N ilk 40.00 rite Hunan HUM US 19,256.62 122.93 OW ale 150.00 nit Uneetffleatlh UNH US 7'7,857.32 78.17 OW ale 90.00 ilk WellPeint VVLP US 31.033.16 106.06 N ale 114.00 ilk Source: Company data. Bloomberg. a Morgan estimates. rit = no change. Al vices as c4 17 Jun14. See page 16 for analyst certification and Important disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Managed Care / Health Care Hendon Justin Lake AC Bloomberg JPMA LAKE <GO, Michael Newshel Neal Miniyar Andrew Toni J.P. Morgan Secumies LLC www.jpmorganmarkets.com EFTA00301317 Jushn Lake North America Equity Research 18 June 2014 J.P.Morgan • We expect market share to shift modestly again in 2015, benefitting HUM. While UNH and WLP saw slight Star improvement for 2015, both am still disadvantaged here vs. peers (UNH 3.5 & WLP 3.3 vs. for-profit peers in 3.84.0 range), adding to competitive pressure when the bonus demo ends next year. Suboptimal Star ratings will likely drive a combination of above-average benefits reductions, physician network culling and plan exits (as well as potentially forcing UNH to add premiums to some zero-premium products). As a result, we conservatively estimate enrollment growth for 2015 to be flat for both UNH and WLP, with market share losses offsetting underlying market growth. Dissecting our county-by-county benefit database, we find that in 90% of those counties where UNH and WLP would see steepest cuts in 2015, HUM offers a competing product within the county. As a result, we are increasing our 2015 HUM MA enrollment growth forecast to 10% from 4% previously, assuming HUM can pick up 25% of UNH's and WLP's assumed market share losses. • Raising HUM 2015 EPS by 7% with de minimis updates to rest of coverage universe. We are raising ow HUM 2015/216 EPS estimates by 7%/1% for 2015/2016 respectively, reflecting our increased market model projections coupled with updates to ow MA margin progression based on mgmt's latest commentary. With de minimis changes to the rest of ow coverage universe and our UNH MA update already incorporated into published #s (updated in our May 2014 note 2014 Medicare Advantage Review and Thoughts on the Road Ahead) ow MCO PTs are largely left intact. • We reiterate our long-term thesis on MA and reiterate our $150 HUM PT. Following our analysis, we reiterate ow long-term constructive thesis on MA and ow Ovenveight rating / $150 PT on HUM, increasing 2015 estimates by 7%, owing to our higher estimates for MA enrollment growth (both higher est industry growth plus market share gains) and earnings. We continue to see a path to $10+ of EPS by 2016 for Humana with another $1+ of potential upside from additional capital deployment and PBM outsourcing optionality. • Our analysis is driven by proprietary actuarial database that translates publicly posted benefit information into the estimated 'value-add" of each MA plan vs. traditional fee-for-service — a key driver of enrollment. Combining this with county/plan specific CMS enrollment data allows us to estimate current and future rebates down to the county/plan/member level and roll up to membership-weighted averages for each company and the industry. This data fills a key gap for investors in understanding how the MA program can absorb the next few years of reimbursement cuts toward FFS parity without threatening long-term viability. Since our initial report in May 2013, we have released over 15 reports surrounding our MA value-add work. 2 EFTA00301318 Justin Lake Overweight Aetna Inc (AET:AET US) Company Data FYE Dec 2011A 2012A 2013A 2014E 2015E (Prey) 2015E (Corr) Price (5) 80.57 Date Of Price 17 Jun 14 EPS Reported (S) 52-week Range (5) 81.25-60.32 Q1 (Mar) 1.48 1.41 1.56 1.98A Market Cap (S mn) 29,408.05 Q2 (Jun) 1.39 1.38 1.62 1.64 Fiscal Year End Dec Q3 (Sep) 1.46 1.61 1.61 1.62 Shares CVS (inn) 365 Q4 (Dee) 1.03 1.00 1.45 1.26 Price Target ($) 82.00 FY 5.36 5.39 6.24 6.50 6.77 6.80 Price Target End Date 31-Dec-14 Bloomberg EPS FY (5) 5.16 5.13 5.88 6.54 7.21 North America Equity Research 18 June 2014 Aetna J.P.Morgan Some: Company data, Bloomberg... Morgan estimates. Investment Thesis, Valuation and Risks Aetna (Overweight; Price Target: $82.00) Investment Thesis Our Overweight rating on AET reflects below-average reform exposure and most importantly an increasing recognition of the company's ACO positioning. We see the Coventry acquisition as providing increased visibility on earnings for 2014/2015, with likely upside to synergies and the accretion estimates going into reform implementation uncertainty. Valuation We have an Overweight rating on Aetna. Our year-end 2014 price target of $82 is based on a PIE of 12x our 2015 cash EPS estimate, below the peer group average and slightly above its current relative valuation. Risks to Rating and Price Target Risks to our rating and price target for Aetna include the potential for medical cost trends to accelerate faster than expected, potential for commercial membership pressure to persist, and changes to the commercial pricing landscape and Medicare / Medicaid reimbursement. With an estimated third of earnings coming from the large group commercially insured segment, should larger full-risk employers choose to exit the health benefits market and instead offer employees a stipend to buy coverage in exchanges (a risk we see as fairly low), we believe Aetna would likely be the most negatively impacted plan in our coverage universe. 3 EFTA00301319 North America Equity Research 18 June 2014 Aetna: Summary of Financials Income Statement - Annual FY13A FY14E FY15E FY16E Income Statement - Quarterly 1O14A 2014E 3014E 4014E Operating revenue 47.195 56.841 61.842 67,587 Operating revenue 13,986A 14,249 14.278 14,349 SG&A (8,373) (10,363) (11,413) (12,372) SG&A (2,490)A (2,547) (2,582) (2,745) Operating income 3,729 4,302 4.479 4,761 Operating ncome 1,322A 1,089 1,046 846 Net Interest (income) /expense (313) (296) (309) (329) Net Interest (income)! expense (66)A (86) (62) (62) Other income / (expense) (215) (155) (145) (140) Other income; (expense) (40)A (38) (38) (38) Pretax income 3202 3.851 4,026 4.292 Pretax income 1,196A 964 946 745 Income taxes (1,102) (1.858) (1.784) (1,850) Income taxes (510)A (411) (405) (332) Net income - GAAP 2241 2.344 2,386 2,582 Net Income GAAP 722A 591 579 451 Diluted shares outstanding 359 360 351 342 Diluted shares outstanding 365A 360 358 357 EPS 8.24 8.50 6.80 7.56 EPS 1.98A 1.64 1.62 1.26 EPS - Recurring 8.24 8.50 6.80 7.56 En-Reaming 1.98A 1.64 1.62 1.26 Balance Sheet and Cash Flow Data FY13A FY14E FY15E FY16E Ratio Analysis FY13A FY14E FY15E FY16E Cash and cash equivalents 1,412 2.127 1,974 1.919 Revenue growth 32.8% 20.4% 8.8% 9.3% Investments 21.115 21.537 21,988 22.407 EBIT growth 20.1% 15.4% 4.1% 6.3% Amounts receivable 1,522 1.552 1,583 1,615 EPS growth 15.7% 4.2% 4.6% 11.1% Current assets 30.654 34.695 37.408 40,644 PP8E 722 704 718 742 SG&A ratio 17.7% 18.2% 18.5% 18.3% Goodwil 9248 9.118 9,197 9,286 Operating margin 7.9% 7.6% 7.2% 7.0% Total assets 49.872 53.834 58.520 59,958 Tax rate 34A% 43.1% 44.3% 43.1% Net margin 4.7% 4.1% 3.9% 3.8% Total debt 8253 8.114 8,451 8,998 Total ledlites 35.848 38,573 40.217 42264 Debt! Capital (book) 37.0% 35.0% 34.1% 33.7% Shareholders' equity 14,028 15,061 16.303 17.695 Return on assets (ROA) 4.9% 4.5% 4.3% 4.4% Return on equity (ROE) 18.3% 18.1% 15.2% 15.2% J.P.Morgan Soiree: Company reports and J.P. Morgan estimates. Note: Sin millions (except per-share data).Fiscal year ends Dec 4 EFTA00301320 North America Equity Research 18 June 2014 Cigna Overweight Cigna Corporation (CI;CI US) Company Data FYE Dec 2012A 2013A 2014E 2015E Price ($) 90.00 EPS Reported (5) Date Of Price 17 Jun 14 01 (Mar) 1.24 1.72 1.83A 52-week Range (5) 91.63-67.87 02 (Jun) 1.49 1.78 1.79 Market Cap (S mn) 24,702.03 03 (Sep) 1.69 1.89 1.91 Fiscal Year End Dec 04 (Dee) 1.60 1.39 1.73 Shares 01S (inn) 274 FY 6.02 6.79 7.26 7.91 Price Target ($) 95.00 Bloomberg EPS FY S 5.91 6.87 7.31 8.04 Price Target End Date 31-Dec-14 Soiree: Company data. Bloomberg. Morgan estimates. J.P.Morgan Investment Thesis, Valuation and Risks Cigna (Overweight: Price Target: 595.00) Investment Thesis We believe Cigna's solid business momentum and strong Medicare Advantage and International segment positioning continue to leave a positive risk/reward with the stock trading at —12x our 2014 EPS estimate, particularly given Cigna's below- average exposure to the 2014 healthcare reform uncertainty. Valuation We rate Cigna Overweight. Our YE 2014 price target of $95 is based on a target PIE of 12x our 2015 EPS estimate. Cigna has historically traded at a discount to the group, but now that it has successfully executed on its PBM option, exited the VADBe reinsurance business, and carries less exposure to reform risk in the initial years, we think a narrow gap is warranted. Risks to Rating and Price Target As with Cigna's peers, medical cost trends could accelerate faster than expected and also, the pricing environment could get more competitive, although Cigna does have below-average exposure to the commercial risk segment. Enrollment growth in the Medicare Advantage segment may be more modest than expected with the potential for rate pressure and 2014 minimum MLR floors to compress margins. Cigna has above-average balance sheet exposure relative to its peers, and run-off books may require future capital infusions should future reserve studies show a need for more capital. EFTA00301321 North America Equity Research 18 June 2014 Cigna: Summary of Financials Income Statement - Annual FY13A FY14E FY15E FY16E Income Statement • Quarterly 1O14A 2014E 3014E 4014E Operating revenue 32,380 33,766 36,345 38,563 Operating revenue 8,4960 8,307 8,411 8,553 SG&A (7.725) (8,140) (8,844) (9,369) SGSA (1,973)A (1,981) (2,053) (2,133) Operatng income 3,083 3,150 3,304 3,584 Operating income 852A 765 807 726 Net Interest (income) /expense 1,164 1,202 1,281 1,323 Net interest (income) expense 277A 306 310 308 Other income y (expense) • - Other income / (expense) • Pretax income 3,083 3,150 3.304 3,584 Pretax income 852A 765 807 726 Income taxes (1,010) (1,173) (1230) (1.319) Income taxes (324)1 (282) (297) (270) Net income - GAAP 1,932 1,951 2.074 2,266 Net income - GAAP 501A 483 510 456 Diluted shares outstanding 285 269 282 256 Diluted shares °Stewing 274A 271 267 263 EPS 6.79 7.26 7.91 8.86 EPS 1.83A 1.79 1.91 1.73 EPS - Recurring 6.79 7.26 7.91 8.86 EPS-Recurring 1.83A 1.79 1.91 1.73 Balance Sheet and Cash Flow Data FY13A FY14E FY15E FY16E Ratio Analysis FY13A FY14E FY15E FY16E Cash and cash equivalents 2.795 2,559 3.628 4,746 Revenue growth 10.8% 4.3% 7.6% 6.1% Investments • - EBIT growth 14.1% 2.2% 4.9% 8.5% Accounts receivable • - EPS growth 12.7% 6.9% 9.0% 12.1% Current assets 24.478 25,591 27,966 30,569 PPM 1,464 1,463 1.471 1,474 SG8A rate 23.9% 24.1% 24.3% 24.3% Goodell Operating margin 9.5% 9.3% 9.1% 9.3% Total assets 54.336 56,339 58,922 61,729 Tax rate 32.8% 37.2% 37.2% 36.8% Net margin 6.0% 5.8% 5.7% 5.9% Total deb! 5,247 5,232 5,232 5,232 Total Iodates 43.659 45,424 46,776 48,254 Debt/ Cannel (book) 33.0% 32.4% 30.1% 28.0% Shareholders' equity 10,677 10,915 12,145 13,475 Return on assets (ROA) 3.6% 3.5% 3.6% 3.8% Return on equity (ROE) 18.8% 18.1% 18.0% 17.7% J.P.Morgan Sowce: Company reports and J.P. Morgan estimates. Note: $ in millions (except per-share data).Fiscal year ends Dec 6 EFTA00301322 Justin Lake Neutral Health Net Inc (HNT;HNT US) Company Data FYE Dec 2011A 2012A 2013A 2014E 2015E Price ($) Date Of Price 52-week Range (5) Market Cap (5 mn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date 40.04 17 Jun 14 40.58-25.40 3,240.12 Dec 81 40.00 31-Dec-14 EPS Reported (5) O1 (Mar) 0.61 0.10 O2 (Jun) 0.76 0.19 O3 (Sep) 0.85 0.38 O4 (Dec) 0.90 0.36 FY 3.09 1. 0.62 0.52 0.83 0.24 2.21 0.39A 0.53 0.69 0.68 2.27 3.05 Source: Company data. Bloomberg. M. Morgan estimates. North America Equity Research 18 June 2014 Health Net J.P.Morgan Investment Thesis, Valuation and Risks Health Net (Neutral; Price Target: $40.00) Investment Thesis Health Net is the last essentially single state based publicly traded health plan, with nearly 90% of the company's current membership located in California. Although the state is a mixed bag (onerous regulatory environment represents a negative, while positives include substantial population including dual eligibles opportunity), in our view, Health Net remains an interesting asset of potential strategic interest. To the downside, the I H'12 earnings shortfall on a variety of medical cost / execution issues highlights the heightened underwriting and earnings volatility that accompanies single-state focused health insurers. Valuation We have a Neutral rating on Health Net. Our YE 2014 price target of $40 is based on a P/E of 13x ow 2015 EPS estimate, in line with the peer group. Risks to Rating and Price Target With Health Net one of the most-levered plans to the Dual Eligible opportunity, there could be downside risk should the demonstration programs be delayed or should results be pressured; there is also risk to the upside should Dual Eligible margins prove to be better than expected. Medical cost trends could accelerate or decelerate faster than expected, leaving downside / upside to our estimates. 7 EFTA00301323 Just., Lake North America Equity Research 18 June 2014 Health Net: Summary of Financials Income Statement - Annual FY13A FY14E FY15E FY16E Income Statement • Quarterly 1414A 2014E 3014E 4414E Operating revenue 10,984 14,047 18.091 19,062 Operating revenue 3,028A 3,516 3,670 3,834 SGSA (1,317) (1,560) (1.857) (1.967) SGBA (386)A (379) (390) (406) Operatng income 245 352 497 522 Operating income 63A 87 103 99 Net interest (income) /expense 37 11 12 14 Net interest (income)/ expense 3A 2 3 3 Other income / (expense) • Other name / (expense) • Pretax income 282 362 509 535 Pretax income 66A AS 106 102 Income taxes (104) (187) (280) (298) Warne taxes (35)A (07) (53) (52) Net income - GAAP 177 176 230 238 Net income GAAP 31A 42 53 50 Diluted shares outstanding 80 77 75 73 Caged shares outstanding 81A 79 76 73 EPS 2.21 2.27 3.05 3.28 EPS 0.39A 0.53 0.69 0.68 EPS - Recurring 2.21 2.27 3.05 3.28 EPS - Recurring 0.39A 0.53 0.69 0.88 Balance Sheet and Cash Flow Data FY13A FY14E FY15E FYISE Ratio Analysis FY13A FY14E FY15E FY16E Cash and cash equivalents 433 271 147 166 Revenue grovnh (1.5%) 21.9% 28.8% 5.4% Investments • EBIT growth 243.6% 43.1% 41.3% 5.0% Accounts receivable • EPS growth 114.2% 3.1% 34.4% 1.2% Current assets 2,920 3,751 4,627 4.886 PPM 201 231 264 300 SG&A ratio 12.0% 11.1% 10.3% 10.3% Goodell Operating margin 2.2% 2.5% 2.7% 2.7% Total assets 3,929 4,765 5,679 5.980 Tax rate 31.1% 51.5% 54.9% 55.6% Net margin 1.6% 1.3% 1.3% 1.2% Total debt 499 499 499 499 Total Iodates 2,300 3,342 4,139 4.371 Debt/ Capital (book) 23.5% 26.0% 24.5% 23.7% Shareholders' equity 1,629 1,423 1,541 1.609 Return on assets (ROA) 4.5% 4.0% 4.4% 4.1% Rerun on equity (ROE) 11.1% 11.5% 15.5% 15.1% J.P.Morgan Sowce: Company reports and J.P. Morgan estimates. Note:5 in millions (except per-share data).Fiscal year ends Dec 8 EFTA00301324 Justin Lake Overweight Humana Inc (HUM:HUM US) Company Data FYE Dec 2012A 2013A 2014E 2014E 2015E 2015E 2010E 2018E (Prev) (Curd (Prey) (Cun) (Pnw) (Cool Prim (5) 122.93 Date Of Price 17 Jun 14 EPS Reported (S) 52-week Range (5) 127.17-81.15 01 (Mar) 1.49 2.95 2.35A 2.35A Market Cap (S mn) 19256.62 02 (Jun) 2.16 2.63 2.13 2.18 Fiscal Year End Dec 03 (Sep) 2.62 2.32 1.96 2.03 Shares 0/S (inn) 157 04 (Dee) 1.19 0.80 1.15 1.23 Price Target ($) 150.00 FY 7.48 8.73 7.58 7.80 8.53 9.12 10.36 10.43 Price Target End Date 31-Dec-14 Bloomberg EPS FY (5) 7.51 8.72 7.81 8.78 - 9.89 North America Equity Research 18 June 2014 Humana J.P.Morgan Source: Company data, Bloomberg. J.P. Morgan estimates. Investment Thesis, Valuation and Risks Humana (Overweight; Price Target $150.00) Investment Thesis Humana's unique earnings profile is the closest thing in the space to a Medicare Advantage pure play with -.60% of operating earnings levered to this segment and a strong market position. Future growth should come from a combination of baby boomer age-ins (turning 65 at the rate of 8,000 per day for the next 18 years), continued market share gains and potential shifts from employers to Medicare Advantage from self-funded employer retiree plans. Based on ow proprietary county-level projections of Medicare Advantage plan benefits, we have increased confidence the industry in general and also HUM in particular will be able to continue to profitably grow Medicare Advantage business despite several more years of reimbursement cuts related to the Affordable Care Act. Finally, the capital deployment opportunity continues to be one of the more interesting areas of optionality for Humana, in our view. Valuation Our 2014 year-end price target of $150 is based on a P/E multiple of .-14.5x our 2016 earnings estimate, a premium to where the broader MCO group is trading. We see potential for the stock's P/E multiple to migrate toward a higher premium as focus shifts from execution to above average secular top-line growth rates in the high single digits with margin improvement potential from scale advantages post 2015 cuts. Risks to Rating and Price Target For Medicare, meaningful risks are associated with health reform regulations coming in more severe than anticipated, including Medicare Advantage cuts, MLR floor implementation and the ability for plans to price through the industry fee. Finally, Medical cost trend could accelerate/decelerate faster than expected. Much of the past few years has been characterized by low medical utilization across the sector, which has driven sizable earnings upside for the Managed Care group. Humana has benefited from a declining trend environment in all of its segments and there could be downside risk should the trend reverse. 9 EFTA00301325 North America Equity Research 18 June 2014 Humana: Summary of Financials Income Statement - Annual FY13A FY14E FY15E FY16E Income Statement • Quarterly 1O14A 2O14E 3014E 4414E Opemong revenue 41313 47,456 55230 59.625 Cperahng revenue 11,712A 11.691 11.910 12.142 SGBA (6,355) (7.201) (7368) (8,495) SG8A (1,666)1 (1.697) (1.782) (2,056) Operating income 2304 2.367 2,775 3,039 Operating interne 721A 640 602 404 Net interest (income) /expense (140) (140) (140) (140) Net interest (income)! expense (35)A (35) (35) (35) Other income I (expense) • • Other income / (expense) Pretax income 2,164 2,227 2,635 2,899 Pretax income 686A 605 567 369 Income taxes (779) (1,011) (1,235) (1,322) Income taxes (318)4 (264) (250) (178) Net income - GAAP 1385 1216 1399 1,576 Net income - GAAP 368A 340 316 191 Diluted shares outstanding 159 156 153 151 Diluted shares outstanding 1510 156 156 155 EPS 8.73 7.80 9.12 10.43 EPS 2.35A 118 103 1.23 EPS - Recurring 8.73 7.80 9.12 10.43 EPS- RecuMng 2.35A 118 103 1.23 Balance Sheet and Cash Flow Data FY13A FY14E FY15E FY16E Ratio Analysis FY13A FY14E FY15E FY16E Cash and cash equivalents 1,138 1,421 1,505 2,097 Revenue growth 5.6% 14.9% 16.4% 8.3% Investments 7,889 9.477 11,103 12,059 BIT gowth 14.3% 2.7% 17.2% 9.5% Accounts receivable 1.280 1,538 1.802 1,957 EPS growth 16.8% (10.6%) 16.9% 14.4% Current assets 12,300 14,242 16.427 18,261 PPM 1218 1,446 1,652 1,854 SG8A ratio 15.4% 15.2% 14.4% 14.2% Goodell 3.641 3.641 3,641 3,641 Operating margin 5.6% 5.0% 5.0% 5.1% Total assets 20,735 23,594 25.798 27,643 Tax rate 38.0% 45.4% 46.9% 45.6% Net margin 3.4% 2.6% 2.5% 2.6% Total debt 2.600 2,598 2,598 2,598 Total Iodates 11,419 13,384 14.763 15,657 Debt/ Caplet (book) 21.8% 20.3% 19.1% 17.8% Shareholders' equity 9316 10,209 11.035 11,987 Return on assets (ROA) 6.8% 5.5% 5.7% 5.9% Return on equity (ROE) 15.3% 123% 13.2% 13.7% J.P.Morgan Source: Company reports and J.P. Morgan esarnates. Note: S in millions (except per-share data).Fiscal year ends Dec 10 EFTA00301326 Juan, Lake Overweight North America Equity Research 18 June 2014 UnitedHealth UnItedliealth Group Inc (UNH;UNH US) J.P.Morgan Company Data FYE Dec 2011A 2012A 2013A 2014E 2015E Price ($) 78.17 EPS - Recurring ($) Date Of Price 17 Jun 14 01 (Mar) 1.22 1.31 1.16 1.10A 52-week Range ($) 83.32-63.43 02 (Jun) 1.16 1.27 1.40 1.23 Market Cap ($ bn) 77.86 03 (Sep) 1.17 1.50 1.53 1.61 Fiscal Year End Dec CA (Dec) 1.17 1.20 1.41 1.51 Shares 0/S (mn) 996 FY 4.73 5.28 5.50 5.45 5.82 Price Target ($) 90.00 Source: Company data. Bloomberg. M. Morgan estimates. Price Target End Date 31-Dec-14 Investment Thesis, Valuation and Risks UnitedHealth (Overweight; Price Target: $90.00) Investment Thesis While retrenching of Med Adv margins has slowed overall earnings momentum in 2014/2015, we estimate that by 2015 more than two-thirds of earnings will be in higher growth businesses of Optum, Medicaid, and Med Adv. What coupled with best-in-class business momentum, diversification, and assets, we expect the stock to migrate toward an S&P multiple in the -15x range. Valuation Our Dec 2014 price target of $90 is based on a multiple of --15x our 2015E EPS, in line with the premium valuation vs. its peers it has historically maintained and reflecting its relatively high exposure to Medicare Advantage, which we think will benefit from long-term secular growth. Risks to Rating and Price Target Healthcare reform represents a pivot point for Managed Care. Considerable uncertainty remains around the 2014 healthcare reform implementation given the multiple moving parts such as exchanges, guaranteed issue, employer dumping, etc. Additionally, the potential for Optum earnings ramp may be slower than expected. Were the earnings ramp here to be more modest than expected (or extend beyond the 2015 target), then that would represent potential downside risk to our numbers and investor sentiment. Finally, UNH faces pressures around medical cost trend acceleration, the potential for increased commercial pricing aggression, and multiple uncertainties in the Medicare Advantage market. 11 EFTA00301327 North America Equity Research 18 June 2014 UnitedHealth: Summary of Financials Income Statement - Annual FY13A FY14E FY15E FY16E Income Statement • Quarterly 1014A 2014E 3014E 4014E Operating revenue 122,489 127,088 130,732 138,219 Operating revenue 31,708A 31.565 31,740 32,075 SG&A (19,362) (21,099) (22254) (23,271) SG8A (5,194)A (5,322) (5,115) (5,468) Operatng income 9,623 9.896 10,216 11,080 Operating income 2,054A 2,290 2,862 2,691 Net interest (income) /expense 37 (27) (12) 8 Net interest (income)! expense 31A (18) (20) (20) Other income; (expense) (708) (649) (649) (651) Other inane! (expense) (160)A (162) (164) (164) Pretax income 8,915 9248 9,567 10,429 Pretax income 1,894A 2,128 2,699 2,527 Income taxes (3,242) (3,893) (4,056) (4,304) Income taxes (795) (910) (1,126) (1,061) Net income - GAAP 5,673 5,355 5,513 6.125 Net income - GAAP 1,049A 1,217 1,573 1,466 Diluted shares outstanding 1,023 983 947 912 Diluted shares outstanding 996A 987 978 970 EPS 5.54 5.45 5.82 6.72 EPS 1.10A 1.23 1.61 1.51 EPS-Recurring 5.50 5.45 5.82 6.72 EPS - Reaming 1.10A 1.23 1.61 1.51 Balance Sheet and Cash Flow Data FY13A FY14E FY15E FY16E Ratio Analysis FY13A FY14E FY15E FY16E Cash and cash equivalents 7276 9.513 10,070 10,666 Revenue growth 10.7% 3.8% 2.9% 5.7% Investments 2.681 2.735 2,789 2.845 Egli growth 4.0% 2.8% 3.2% 8.4% Accounts receivable 2.387 2.434 2,483 2.533 EPS growth 5.0% (1.7%) 6.8% 15.4% Current assets 20,380 24,706 25,699 27,190 PPM 3.945 4236 4.639 5.073 SG8A ratio 15.8% 16.6% 17.0% 16.8% Gootholl 28,779 28,739 29,348 30,126 Operating margin 7.9% 7.8% 7.8% 8.0% Total assets 81,882 86,419 89,034 92,516 Tax rate 36.4% 42.1% 42.4% 41.3% Net margin 4.6% 4.2% 4.2% 4.4% Total debt 16,860 16,765 16,765 16,765 Total hadlibes 49,733 52,165 53,267 55,123 Debt/ Capital (book) 34.4% 32.9% 31.9% 31.0% Shareholders' equity 32,149 34,255 35,768 37,393 Return on assets (ROA) 6.9% 6.4% 6.3% 6.7% Return on equity (ROE) 17.8% 16.1% 15.7% 16.7% J.P.Morgan Saute: Company reports and J.P. Morgan estimates. Note: S in millions (except per-share data).Fiscal year ends Dec 12 EFTA00301328 North America Equity Research 18 June 2014 WellPoint Neutral WellPoint Inc (WLP:WLP US) Company Data FYE Dee 2011A 2012A 2013A 2014E 2015E 2015E Price ($) 108.06 (Prey) (Curr) Date Of Price 17 Jun 14 EPS Reported (S) 52-week Range ($) 110.03-77.40 Q1 (Mar) 2.35 2.34 2.94 2.30A Market Cap ($ bn) 31.03 Q2 (Jun) 1.83 2.04 2.60 2.25 Fiscal Year End Dec Q3 (Sep) 1.77 2.09 2.10 2.09 Shares O/S (mn) 293 Q4 (Dee) 0.99 1.03 0.87 1.84 Price Target ($) 114.00 FY • 8.52 8.51 9.54 9.53 Price Target End Date 31-Dec-14 Source: Company data. Bloomberg. J.P. Morgan eabmatea. J.P.Morgan Investment Thesis, Valuation and Risks WellPoint (Neutral: Price Target $114.00) Investment Thesis WellPoint's strong brand and significant size provide meaningful competitive advantages. At over 33 million medical members nationwide, WellPoint is the largest health insurer from an enrollment perspective with its significant scale and broad reach providing the company with unique competitive advantages with regard to provider network discounts and breadth, SG&A leverage, and investment spend capacity. Furthermore, WellPoint holds a Blue Cross and/or Blue Shield license in 14 states, providing the company with the strength of the Blues brand name as well as decreased competition from Not-for-Profit Blues, which are typically the most difficult competitor in any state. While execution in the Consumer business has been an issue, margins lag peers, leaving potential for improvement moving forward. The acquisition of Amerigroup adds not only significant growth potential in the Medicaid Managed Care and Dual Eligibles space but also a strong management team with a history of solid execution, in our view. Valuation Our Dec 2014 price target of $114 is based on a multiple of --I2x our 2015 earnings estimate, in line with the stock's historical average discount vs. the group. Risks to Rating and Price Target Individual and Small Group exposure leaves uncertainty around exchanges. We estimate that WellPoint derives nearly 30% of its 2012 earnings from the Individual and Small Group markets, which are the most likely to see meaningful disruption with the advent of exchanges in 2014. Improved execution presents upside risk after years of significant missteps with WellPoint's performance in recent years headlined by various self-inflicted missteps, most recently by its challenges in the California Medicare Advantage market. Integration and execution risk also may be heightened following the acquisition of Amerigroup, which should be accretive in its first year (2013). The potential for increased Commercial pricing aggression persists as pricing yields have outpaced commercial cost trends in recent years with publicly traded plan commentary and J.P. Morgan channel checks indicating that the pricing environment 13 EFTA00301329 Justka Lake North America Equity Research 18 June 2014 J.P.Morgan remains largely rational outside of pockets of increased pricing aggression related to minimum medical loss ratio floors. Finally, medical cost trends could accelerate or decelerate faster than expected leaving downside/upside to our estimates. 14 EFTA00301330 Justin Lake North America Equity Research 18 June 2014 WellPoint: Summary of Financials J.P.Morgan Income Statement - Annual FY13A FY14E FY15E FY16E Income Statement • Quarterly 1O14A 2014E 3O14E 4O14E Operable revenue 70,522 73,220 79.005 Operating revenue 17.645A 18,233 18.569 18,773 SG&A (10,061) (10.554) (10,963) SG8A (2.632)1 (2.631) (2.644) (2.648) Operable income 4,860 5.041 5,421 0 Operating income 1,333A 1,329 1,249 1,129 Net interest (income) /expense 56 86 64 Net interest (income)! expense 38A 16 16 16 Other income y (expense) • Other income / (expense) • • Pretax income 3,850 4.229 4,617 Pretax teams 1,130A 1,127 1,046 926 Income taxes (1,200) (1.765) (2,014) Income taxes (439)1 (475) (447) (405) Net income - GAAP 2,650 2.464 2,603 Net income - GAAP 691A 652 600 521 Diluted shares outstanding 304 287 273 265 Diluted shares outstaning 293A 290 287 284 EPS 8.72 8.57 9.53 EPS 2.36A 2.25 209 1.84 EPS -Recurring 8.52 8.51 9.53 10.62 EPS - RecuMng 2.30A 2.25 209 1.84 Balance Sheet and Cash Flow Data FY13A FY14E FY15E FY16E Ratio Analysis FY13A FY14E FYISE FY16E Cash and cash equivalents 1,582 1.105 232 - Revenue growth 16.1% 3.8% 7.9% • Investments 19,543 21,942 27,034 EBIT growth 5.1% 3.7% 7.6% Accounts receivable 5,465 5.675 6,123 EPS growth 6.7% (1.7%) 11.1% Current assets 29,746 31,876 33,388 PPS! 1,802 1.747 1,675 SOM ratio 14.3% 14.4% 13.9% Goodwd 21,6-U 21,632 29,307 Operating margin 6.9% 6.9% 6.9% Total assets 59,575 62,552 64,371 Tax rate 31.2% 41.7% 43.6% Net margin 3.7% 3.3% 3.3% Total debt 14,492 15,041 15,041 Total ItatilitieS 34,809 37,634 39,099 Debt 1 Capital (book) 36.9% 37.6% 37.3% Shareholders' Cary 24,765 24,918 25,271 Return on assets (ROA) 4.4% 4.0% 4.1% 8.7% Return on equity (ROE) 10.7% 9.8% 10.4% 22.3% Smrce: Company reports and J.P. Morgan estimates. Note: Sin millions (except per-share data).Fiscal year ends Dec 15 EFTA00301331 Justil Lake North America Equity Research 18 June 2014 J.PMorgan Analyst Certification: The research analyst(s) denoted by an "AC" on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an "AC' on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that (I ) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no pan of any of the research analyst's compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report. For all Korea-based research analysts listed on the front cover, they also certify, as per KOFIA requirements, that their analysis was made in good faith and that the views reflect their own opinion, without undue influence or intervention. Important Disclosures • Market Maker: JPMS makes a market in the stock of UnitedHealth. • Lead or Co-manager: J.P. Morgan acted as lead or co-manager in a public offering of equity and/or debt securities for Aetna, Humana, UnitedHealth, WellPoint within the past 12 months. • Beneficial Ownership (1% or more): J.P. Morgan beneficially owns I% or more of a class of common equity securities of WellPoint. • Client: J.P. Morgan currently has, or had within the past 12 months, the following company(ies) as clients: Aetna, Cigna, Health Net, Humana, UnitedHealth, WellPoint. • Client/Investment Banking: J.P. 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Morgan uses the following rating system: Overweight (Over the next six to twelve months, we expect this stock will outperform the average total return of the stocks in the analyst's (or the analyst's team's) coverage universe.] Neutral [Over the next six to twelve months, we expect this stock will perform in line with the avenge total return of the stocks in the analyst's (or the analyst's team's) coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperfonn the average total return of the stocks in the analyst's (or the analyst's team's) coverage universe.] Not Rated (NR): J.P. Morgan has removed the rating and, if applicable, the price target, for this stock because of either a lack of a sufficient fundamental basis or for legal, regulatory or policy reasons. The previous rating and, if applicable, the price target, no longer should be relied upon. An NR designation is not a recommendation or a rating. In our Asia (ex-Australia) and U.K. small- and mid-cap equity research, each stock's expected total return is compared to the expected total return of a benchmark country market index, not to those analysts' coverage universe. If it does not appear in the Important Disclosures section of this report, the certifying analyst's coverage universe can be found on J.P. Morgan's research website, www.jpmorganinarkets.com. Coverage Universe: Lake, Justin: Aetna (AFT), Centene (CNC), Cigna (CI), Community Health Systems (CYH), DaVita HealthCare Partners Inc (DVA), HCA (HCA), Health Net (HNT), Humana (HUM), LifePoint (LPNT), Molina (MOH), Surgical Care Affiliates (SCAI), Tenet (THC), UnitedHealth (UNIO, Universal Health Services Inc. (UHS), WellPoint (WLP) 16 EFTA00301332 Juslin Lake North America Equity Research 18 June 2014 J.P. Morgan Equity Research Ratings Distribution, as of March 31, 2014 Overweight Neutral (buy) (hold) Underweight (sell) J.P. 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