Tuesday, 17 February 2015

DaVita Healthcare: on the watch list

Let's talk about DaVita Healthcare one of the world's largest integrated provider of products and services for individuals undergoing dialysis because of chronic kidney failure. Unfortunately this is a growth industry due predominately to 'lifestyle changes' as this recent chart from a Cancer Research update unfortunately shows:

DaVita shares have struggled a little over recent months but technically are back to an interesting level at around the US$72/share level so it is a good time to look at them - and also especially as Buffett (via one of his internal managers predominately) is also a material shareholder holding over 17% of the shares.

Of course DaVita is not a pure dialysis and related play as it bought a couple of years ago HealthCare Partners a physician practice management business.  Nevertheless the dialysis business remains over 85% of group profitability.  

The first aspect I note about the company is the effectively operating profitability is estimated to be flat in 2015 year-on-year with FY14A profitability of US$1.82bn (+17% yoy) and a FY15e guidance range of US$1.75-1.9bn.  

Now DaVita has had a number of challenges due to Medicare/Medicaid remuneration who cover around 90% of their patients but for whom, on an average case basis, generate revenues which barely cover the cost of the treatment even today - and that is before potential further cuts next year. Yes it is the commercial payers who contribute materially to DaVita's bottom line.  

And then there have been the court cases.  In October the company agreed to pay US$389 million to settle civil charges that it was paying kickbacks to doctors over a 10-year period in order to boost referrals to its clinics.  Not a huge sum given the near US$16bn market cap of the company and, of course, they did not admit guilt.  

With net debt a little under x3 ebitda the company trades on just over x12 EV/ebit FY15e.  For a positive theme company this would be way too cheap...however DaVita has its pressures.  It also has a near 5% free cash flow yield too and some call option artificial kidney projects rumbling away (with a target for clinical trials in 2017). 

I noted on last week's Q4/FY conference call transcript, the continued mention of an upcoming investor day in May.  That feels like an important potential catalyst.  

Ultimately only so much pressure can be put on these companies and with DaVita and its great competitor Fresenius being a clear majority (maybe 70-80%) of the market it is not as if new competitors are primed to emerge given the required investment required to build up coverage.  Of course technology may ultimately curb the need for so many centres but then it would come down to the importance of know-how and access to doctors...which funnily enough is the minority aspect of the company as noted above.  

Putting it all together I am looking to buy a starter position for my pension fund in DaVita in the US$70-72 share price range i.e. one bad day away from here.  

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