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Buy DaVita: The last week has taken a good deal of the risk out of the shares
04/05/2013 6:18 pm EST
Certainly I’m glad to see the end of some of the general macro uncertainty of the last few days. We know what the European Central Bank and the Bank of Japan have decided and we know what today’s jobs numbers were for the U.S. economy in March. All this news should be in stock prices now.
But the big de-risking of DaVita actually was company specific and took place on Monday, April 1. Worries that Medicare would cut reimbursements for patients in the Medicare Advantage program had been hanging over the stock since February when the Centers for Medicare and Medicaid Services had said reimbursement payments could fall by more than 2% in 2014. On April 1, and it wasn’t a joke, the agency reversed that projection and said that instead it expects that reimbursements will climb by 3% in 2014.
That’s not an insignificant change since patients covered by Medicare and Medicaid make up 90% of the patients treated by DaVita and 66% of revenue. DaVita is very good at controlling costs and managing margins—which is one of the reasons that I like this stock. In the fourth quarter, for example, administrative costs per treatment fell by 2.4%. But it sure is easier to keep margins steady—or increase them—if government reimbursement isn’t falling.
DaVita has two businesses that put it at the heart of two important healthcare trends.
First as operator of 1,990 dialysis clinics and with about 33% of the U.S. dialysis market, DaVita is well positioned for the continued growth of diabetes in the United States. An aging population and growing obesity have driven a steady 4% annual growth in diabetes patients in the United States over the last decade. Morningstar projects average annualized growth in DaVita’s dialysis services unit of 7.3%.
Second, in DaVita acquired Healthcare Partners, a physician group manager that coordinates care for 1,600 physicians, 6,500 specialists, and 111 hospitals primarily in California, Florida, and Nevada. The acquisition put DaVita in the business of managing costs—and hopefully lowering them through efficiencies—in the healthcare system. This business builds on DaVita’s history of managing costs in its dialysis unit at a time when managing costs—while delivering good service—is at the key of the Obama administration’s hopes for the Affordable Care Act. Morningstar projects that this part of DaVita’s business will be able to grow revenue at a double-digit rate. (I suspect that it's the combination of two predictable and steadily growing businesses that has led Warren Buffet’s Berkshire Hathaway (BRK.A or B) to acquire shares of DaVita.)
Standard & Poor’s projects earnings per share of $7.36 in 2013 and $8.37. Those estimates give the stock a forward price-to-earnings ratio of 17 on projected 2013 earnings per share and 15 on projected 2014 earnings per share. Not terribly expensive given the projected earnings growth of 19.8% in 2013.
My one-year target price on these shares is $149.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/, I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund did not own shares of DaVita as of the end of December. For a full list of the stocks in the fund as of the end of December see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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