Two Stocks That Can Give Life to a Portfolio

Two Stocks That Can Give Life to a Portfolio
By JOHANNA BENNETT | MORE ARTICLES BY AUTHOR
Growing demand and cost savings will help dialysis providers DaVita and Fresenius weather changing Medicare rules.

Dialysis -- the artificial process of removing impurities from blood -- is a necessary ordeal for hundreds of thousands of Americans who suffer from kidney failure.

So it's been money in the bank for DaVita (ticker: DVA) and Fresenius Medical Care (FMS), the world's two largest operators of dialysis clinics.

While patients can't live without the services these companies provide, investors haven't always seen the promise of their stocks.

Fears surrounding Medicare cuts, which were put into effect on Jan. 1, fueled a selloff for both stocks late last year.

Now, a nascent recovery by the stocks could continue as DaVita and Fresenius offset lower Medicare payments, and cash in on rising demand for their services here and abroad.

To be sure, neither stock is a screaming bargain, trading at just under 18 times forward earnings.

But as profits rise, so too will share prices.

"Both companies can prevail," says Wendy Trevisani, a portfolio manager with Thornburg Investment Management. "They have the scale, quality of service and the ability to manage costs, as well as strong balance sheets to fund accretive acquisitions."

Others agree.

At A Glance
DaVita (DVA)
Stock Price:    $76
52-Week High:    $78.28
52-Week Low:    $56.58
Market Cap:    $ 7.4 billion
Est. 2011 EPS:   $4.45 per share
Fwd P/E:    17.7 times
Est. Long-Term EPS Growth:*   12%
Est. ('11/'10) EPS Growth:    2%
Revenue (trailing 12 months):   $6.4 billion
Dividend Yield:    None
CEO:    Kent J. Thiry
Headquarters:   Denver, Colo.
* Based on analyst estimates looking ahead three to five years.

Sources: Yahoo! Finance; Thomson Reuters

Goldman Sachs initiated coverage of DaVita at a Buy in December with a $90 price target, an 18% premium to today's close. And SunTrust Robinson Humphrey sees Fresenius' U.S.-listed American depositary receipts climbing 16% to $73 a share.

"It's a stable industry with predictable fundamentals, and because of that, it should be a core holding of every health-care investor," says Andreas Dirnagl, an analyst at Stephens, an investment bank based in Little Rock, Ark.

Roughly two million people worldwide – 370,000 in the U.S. – receive regular dialysis treatments because their kidneys can't remove toxins from their blood.

That number, however, could double by 2020 as emerging markets keep improving their health-care services and the occurrence of high blood pressure and diabetes (leading causes of kidney failure) rises in the United States.

But to quell rising health-care costs, U.S. officials have changed payment rules for Medicare, bundling the various payments made to dialysis clinics into one smaller, lump-sum reimbursement.

Because it operates only in the U.S., DaVita gets roughly 60% of its revenue from Medicare. Fresenius, meanwhile, owns clinics outside the U.S., so it relies on Medicare for just 40% of its business, says Stephens' Dirnagl.

Still, analysts see profits at both companies growing an average of 11% to 12% annually over the next three to five years.

Some of the improved profitability is a function of cost cutting. For example, new treatment protocols should reduce the use of expensive medications. And companies are renegotiating the prices for supplies.

Meanwhile, developing regions such as Latin America, Asia and Eastern Europe – where patient populations are growing 6% to 10% annually – offer lucrative prospects for expansion.

That's an opportunity DaVita, the second-largest dialysis provider in the U.S., is exploring.

In the meantime, it is still adding to its network of 1,598 U.S. clinics. Last week, the Denver-based company agreed to acquire DSI Renal for $690 million.

The deal, which closes in the next four months, could add 35 cents a share to annualized earnings. Add to that share repurchases, and DaVita's earnings power could exceed $6 a share in 2012, says Stephens' Dirnagl.

At a Glance
Fresenius Medical Care (FMS)
ADR Price:*   $62.77
52-Week High:    $64.12
52-Week Low:    $47.19
Market Cap:    $18.9 billion
Est. 2011 EPS:   $3.54 per share
Fwd P/E:    17.8 times
Est. Long-Term EPS Growth:**   11%
Est. ('11/'10) EPS Growth:    9%
Revenue (trailing 12 months):   $11.9 billion
Dividend Yield:    0.90%
CEO:    Dr. Ben J. Lipps
Headquarters:   Bad Homburg, Germany
*American depositary receipts
**Based on analyst estimates looking ahead three to five years.

Sources: Yahoo! Finance; Thomson Reuters

DaVita is expected to report 2010 earnings of $4.37 a share when it closes the book on its fourth-quarter financial performance on Feb. 10.

Up 24% over the last 12 months, the stock trades at 17.7 times projected earnings over the next 12 months.

For now, however, Fresenius remains the leading provider of dialysis in the U.S. and globally, with 2,580 clinics that treat 199,000 patients.

The German-based company is also the most diverse player in the industry, says Thornburg's Trevisani.

Dialysis clinics in the U.S. generate 60% of its revenue. But Fresenius also manufactures and sells dialysis equipment and supplies to clinics here and abroad.

Emerging markets generate roughly 12% of Fresenius' revenue (which the company reports in U.S. dollars), says Stephens' Dirnagl. And last month, the company spent $650 million to purchase International Dialysis Centers from Euromedic International, expanding Fresenius' operations in Eastern Europe.

Profit is expected to climb 9% this year to $3.54 a share.

Yet at $62.78 a share, Fresenius, which trades at 17.8 times forward earnings, has lagged rival DaVita: Fresenius stock climbed 25% over the last 12 months.

Of course, altering Medicare payment rules can have an unforeseen impact on profits. And future funding always remains uncertain.

DaVita and Fresenius have generated considerable amounts of debt on a rash of acquisitions. And high unemployment has hurt revenue generated by lucrative payments from private insurers.

Still, as leaders in a strong and growing industry, DaVita and Fresenius can still provide healthy returns.

Full Disclosure

• Goldman Sachs and/or one of its affiliates has received compensation for investment-banking services from DaVita in the last 12 months, and expects to receive or intends to seek compensation for investment-banking services from DaVita in the next three months, according to a disclosure statement. Goldman has a Buy rating on the stock.

• SunTrust Robinson Humphrey and/or one of its affiliates has received compensation for investment-banking services from Fresenius Medical Care in the last 12 months, according to a research note published on Jan. 4. SunTrust has a Buy rating on the company's American depositary receipts.

• Stephens Inc. and/or one of its affiliates intends to seek compensation for investment-banking services from DaVita in the next three months, according to a research note published on Feb. 4. Stephens has an Overweight rating on the stock.

• Stephens Inc. has an Overweight rating on Fresenius Medical Care's American depositary receipts.

• Thornburg Investment Management held 1,688,676 of Fresenius Medical Care's American depositary receipts as of Sept. 30, 2010, according to StreetSight.net.

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