A Life or Death Stock

THURSDAY, APRIL 30, 2009
WEEKDAY TRADER
A Life or Death Stock
By JOHANNA BENNETT | MORE ARTICLES BY AUTHOR
DaVita offers investors a play on a health service that patients can't do without.

THOUGH MAJOR STOCK indexes have rebounded mightily over the past two months, DaVita (ticker: DVA), the nation's second-largest chain of kidney dialysis clinics, has for the most part been left out of the rally.

Yet profits are climbing at a brisk pace and the stock offers investors a compelling opportunity.

Up only 5% since the market rally started on March 9, DaVita's stock has been hobbled for much of the time by worries about health-care reform and concern that the economy and job cuts will hurt lucrative payments from private insurers.

But kidney-failure patients need dialysis to survive. And demand is rising as Americans grow older, fatter and sicker.
At a Glance
DaVita (DVA)
[DVA]
Stock Price:    $46.56
52-Wk High:    $60.20
52-Wk Low:    $40.96
Market Cap:    $4.8 billion
Est. 2009 EPS:    $3.82 per share
Fwd P/E:    11.9x
Est. Long-Term EPS Growth*:    12%
Est. ('09/'08) EPS Growth:    8%
Revenue (trailing 12 months):    $5.6 billion
Dividend Yield:    None
CEO:    Kent. J. Thiry
Headquarters:    El Segundo, Calif.
* Based on analyst estimates looking ahead three to five years.
Sources: Thomson Reuters

Medicare reimbursements should remain stable next year. And private-insurance payments, which generate one-third of DaVita's revenues, also remain strong.

"It's a stable and predictable business," says Andreas Dirnagl, an analyst for Stephens, an investment bank. "Over the next year, these guys will meet or beat expectations, and assuage fears."

Others agree.

Up 10% since Wachovia Capital Markets initiated the stock at Outperform on April 23, the shares could climb another 22% to 27%, says Gary Lieberman, Wachovia's analyst.

Piper Jaffray, meanwhile, raised its rating on Monday to Buy from Neutral.

The next day, DaVita announced that profits grew more than expected last quarter, illustrating the company's "ability to efficiently grow with no observed impact from the weak economy," wrote Piper Jaffray analyst Mark Arnold.

Once called Total Renal Care Holdings, DaVita treats 110,000 kidney-failure patients in the U.S. in more than 700 hospitals and 1,400 free-standing clinics.

With revenues of more than $5.6 billion last year, the company now controls 27% of the U.S. market.

The nation's poor health is good news for dialysis clinics.

Already, more than 350,000 Americans receive dialysis because their kidneys can't remove toxins from their blood.

But as the population grows, and baby boomers age, there will be a greater occurrence of diabetes and high blood pressure (the leading causes of kidney failure).

By 2020, the demand for dialysis could spike more than 50%, according to the U.S. Renal Data System, a federally funded database.

Meanwhile, DaVita's bad debt (revenue lost to patients' unpaid medical bills) remains low at 2.5% of total sales.

Why? Because 72% of DaVita's patients are on Medicare.

In fact, kidney-failure patients receiving dialysis for 33 consecutive months qualify for Medicare, regardless of their age.

But depending on Medicare can wreak havoc when funding for the government-run program gets cut or changed, as it was in 2008. Plus, private insurers pay DaVita far more than Medicare for each patient's treatment, thus generating fatter profits.

Last year, private insurers covered 14,500 of DaVita's patients, and paid $922 on average for each treatment, while Medicare payments averaged $249 per treatment, according to Wachovia's Lieberman.

By 2010, private insurers could pay over $984 per treatment, he adds.

Unfortunately, big health insurers recently reported big drops in commercial health-plan enrollment, raising fears that more patients will shift to Medicare, hurting DaVita's profitability.

But the not-for-profit American Kidney Fund (AKF) gave grants to 40,000 financially needy dialysis patients last year to pay insurance premiums.

And this year, the program -- funded by dialysis clinics -- could increase 15% in size, says Tamara Ruggiero, the organization's spokeswoman.

DaVita officials were not available to comment. No information was immediately available regarding what portion of DaVita's patients got help from the AKF.

But in 2010, DaVita should treat 15,620 commercially insured patients, says Wachovia's Lieberman.

As a result, the Street expects DaVita's profits to climb 8% this year and another 10% in 2010 to $4.17 a share, according to Thomson Reuters.

Meanwhile, the company expects free cash flow to reach $400 million to $450 million this year, says Lieberman.

"A lot of things are going right," Chief Executive Kent Thiry told investors during a conference call earlier this week.

Still, DaVita fetches a big discount.

At less than 12 times projected earnings over the next four quarters, DaVita trades below its five-year median of 17 times forward earnings and at a 19% discount to the health-care-services stocks monitored by Thomson Reuters.

Still, even DaVita's Thiry warned investors earlier this week that "no one is totally insulated from an economic recession." And a stock sale by Thiry in September raised some eyebrows (see Inside Scoop, "DaVita Head Sells $2.6 Million in Stock," Sept. 25, 2008.)

Commercial pricing could falter. Plus, profits will get hit if Medicare or President Obama's plan to create a government-run health plan siphons patients away from commercial insurers.

But as a leader in a strong industry with plenty of cash, little bad debt, and the likelihood of good future growth, DaVita stock may be ready for a rally of its own.

Full Disclosure
• Piper Jaffray has a Buy rating on DaVita.

• Wachovia Capital Markets has an Outperform rating on DaVita.

• Stephens has an Overweight rating on DaVita.

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