Buy DaVita Inc (DVA, $54-56, Mkt Cap: $9-10B)
Company Description: Davita Inc. is one of the largest kidney dialysis service providers in the United States, with 2,293 outpatient dialysis centers treating 185,000 patients. DVA also operates 127 outpatient dialysis centers in 11 foreign countries, serving a total of 11,000 patients.
DVA Investment Summary: DVA has sold off from market weakness, delays to the DMG/HCP divestment to UNH, and union issues in California. At 7-7.5x pro-forma EBITDA, DVA is trading below its 10x historical average and a material discount to its P/E average (current 12x vs. hist avg 18x). We see 3 factors that could make DVA go up: 1. Closing the HCP/DMG medical group divestiture to UNH as it did not work as planned and allows investors to re-focus on a pure-play dialysis business. 2. Stable to improving dialysis reimbursement and consistent volume growth; 3. Improving capital structure allowing for reduced debt and more share buybacks.
Key Metrics to Watch:
Patient Mix: Stable Commercial vs. Gov't
Volume growth: +3-5%
Rev growth
Margins
Cash flow: $700-900M in FCF
Key Risk to Watch: SEIU & UHW are trying to unionize DVA employees in California but dialysis industry are fighting it. Unions are playing hard ball by trying to pass legislation that could negatively impact DVA's business. They failed twice: 1. public vote favored dialysis where unions were outspent by $90M and then separately a governor's veto. With a new governor, it is hard to handicap what comes next but the unions are not giving up. We see the downside at about $100M in operating income (about 6-8%) but the stock may be volatile.
Key Thesis Points:
· DMG sale to UNH's Optum in 1Q18: Will reduce debt, increase financial flexibility, and add to share bb's. Selling DMG for $4.34B to UNH; FTC review ongoing (not during gov't shutdown); working towards 1Q19 close. $3B will go to debt paydown and +$1B to bb's.
· EBT margins will inflect & EPS will accelerate after deal close based in pre-deal 2019 guidance: Selling DMG for $4.34B to UNH; FTC review ongoing; working towards 1Q19 close. DVA will likely pay down $3B of debt to get between 3.0-3.5x leverage and buyback $1-1.3B in stock. Cons reflects int exp of DMG but no profits as it moves to disc ops.
· Share repurchase may support stock performance: Going forward: DVA plans to focus on returning capital to shareholders in the form of share bb's. DVA generates $600-800M in FC (7-10% yield at $55) on top of +$1B post DMG sale.
· Valuation metrics at all-time low support an attractive entry point (see valuation graphs below)
· Stable to Improving Pricing: Medicare reimbursement has accelerated 100bs in 2019 to +1.6% and will likely be stable from here in the +1-1.5% range. It was a headwind from 2013-2017 due to a shift to a bundled reimbursement.
· Growth:+ 3-4% growth (range +3-6%) from patient growth and zero pricing
· In 2021 patients can choose higher paying Med Adv plans for the first time. Currently Med Adv is 40% of seniors vs. 10-15% of ESRD seniors. This could add +2-3% a year and offset comm’l mix pressure.
· Demographically driven growth and commercial mix pressure as baby boomers age into Medicare. In 2018-2020 offsets to commercial weakness includes improving Int’l results, better Medicare rates and lower EPO costs.