Thursday, April 3, 2014 | By Terrri Tinker | 1 Comment
DaVita: Short-Term Headwinds Could Create Buying Opportunity For Long-Term Investors
DaVita’s reliance on third-party payments are causing some short-term headwinds.
DaVita’s services are essential and must be provided for, providing long-term security for investors.
Worldwide demand for dialysis is anticipated to grow 6-7% per annum.
DaVita Healthcare Partners (DVA) is one of the leading U.S. providers of services for patients suffering from chronic kidney failure. Along with Fresenius Medical Care (FMS), almost 70% of the U.S. dialysis market is controlled.
Completed in November of 2012, the $4.4 billion merger with HealthCare Partners added a privately held physician practice network to DaVita. While the merger does have the benefit of increasing revenue diversity, there is another benefit which was created. Competition is strong for the all-important commercially insured patients. The HealthCare Partner physicians, now part of the same company as DaVita, are more likely to send their patients to DaVita controlled dialysis centers. 2013 adjusted operating income was $385 million for HealthCare Partners, representing just over 20% of DaVita’s total, with Kidney Care the remainder.
Operating earnings for HealthCare Partners is expected to be under pressure in 2014. DaVita had anticipated OE to come in between $250 and $310 million. During the recent earnings call, DaVita stated that it now expects 2014 numbers to be at the low end of those figures, which would represent a significant decline from 2013. DaVita expects Kidney Care 2014 operating earnings to be between $1.475 and $1.550 billion. The low estimate represents an increase of $10 million; the high estimate represents an increase of $50 million. Neither is particularly substantial.
When asked about the guidance for 2014 with HCP, DaVita had this to say:
the change in our perspective on ’14 is almost entirely driven by the fact that the FTC has been slow on approving merger to plans in that market and some of our new contractual provisions are not triggered until that deal is consummated. That’s why there’s the adjustment in our thoughts on ’14.
Kidney Care is also not immune from troubles in 2014. DaVita has a strong reliance on third-party payments, including Medicare and Medicaid. Back in July of 2013, it was announced that the U.S. Medicare system proposed cutting payments for dialysis services by 9.4%. This sent DaVita shares tumbling down 5.9% for the day. As it turned out, Medicare is leaving its reimbursement rate for dialysis services unchanged in 2014. In order to minimize disruptions to both providers and patients, rate cuts will be done over a multi-year period.
That near 6% fall in share price gives some insight into the importance investors assign to the issue. Perhaps overlooked by some investors, most of DaVita’s profits actually come from commercially insured treatments. Both Medicare and Medicaid covered patients do make up 90% of DaVita’s treatments, but margins on these particular patients are extremely low. Most of DaVita’s profits come from commercial insurers, even though they only make up 10% of treatments. Unfortunately, on top of Medicare and Medicaid, increased commercial rate pressure and the potential impact of exchanges are some additional headwinds DaVita will be facing in 2014.
This all adds up to a lot of uncertainty in the short-term. Long-term, DaVita remains an excellent play. The short-term uncertainty actually stands to benefit the long-term outlook in certain respects. The uncertainties could create buying opportunities with the stock price. In addition, DaVita is better suited than smaller companies to withstand this environment, and may be able to deploy its substantial cash flows to make acquisitions at favorable prices. DaVita is not unique in the fact that 10% of their private patients subsidize the 90% which aren’t, when it comes to dialysis services. Dialysis services are not going anywhere, and they remain a public necessity. Medicare rates can’t continue to go down if commercial rates also are. It’s an essential service.
The number of patients needing dialysis worldwide is projected to grow 6-7% annually. The existing market leaders, Fresenius and DaVita, enjoy large cost advantages and benefits of economies of scale which will aid them in maintaining market share. Moving forward DaVita should enjoy higher international growth rates than Fresenius, because DaVita has just begun international expansion and is starting from a smaller base. A recent announcement demonstrates some of the success which is anticipated to continue. The deal is with the Kingdom of Saudi Arabia’s Ministry of Health. DaVita will be treating 5,000 of the 10,000 dialysis patients under the Ministry’s care.
DaVita also happens to be Berkshire Hathaway’s (BRK.A) favorite stock to add to its famed investment portfolio recently. It should be noted that Tim Weschler, who along with Todd Combs is in charge of $14 billion of Berkshire’s investments, is the one buying DaVita, not Buffett. Nevertheless, it represents a tremendous vote of confidence. As Buffett himself has been readily admitting in his shareholder letters, they’ve been generating much higher returns than he has recently.
Just recently Berkshire purchased an additional 1.13 million shares, bringing their total to 37.62 million, which is a 17.7% stake. At current prices, that represents over $2.5 billion in value. Berkshire has an agreement in place with DaVita stating that it will not purchase more than 25% of the company. That still currently leaves Berkshire with the ability to purchase a good deal of more shares. Despite DaVita shares being at their all-time high, Berkshire shows no signs of slowing down.
DaVita possess many of the traits typical of companies in Berkshire’s portfolio. First and foremost is a high margin of safety. The increase in diabetes and obesity-related conditions will sustain the need for dialysis services for many years to come. DaVita truly is one of the rare companies that are legitimately recession proof. Those in need of dialysis will die without it. It has to be done. That long-term fundamental story remains intact.
Additional disclosure: I may initiate a long position in DVA over the next 72 hours.
— Sean Weston, March 21, 2014 www.seekingalpha.com