DaVita
the dialysis cannibal!
By Manuel Maurício
April 29, 2022
Symbol: DVA (NYSE)
Share Price: $109.9
Market Cap: $10.45 Billion
DaVita’s largest shareholder is none other than Warren Buffett, with 38% of the company owned by Berkshire Hathaway.
This fact alone wasn’t enough to get me interested, but I’ve been seeing increased chatter about the company from investors whom I admire so I decided to take a closer look.
DaVita's business
DaVita is the second largest provider of dialysis services in the US, just behind Fresenius. The two together have 70% share of the market with the remainder distributed among smaller players.
DaVita’s patients suffer from chronical kidney failure, also known as end-stage renal disease or end-stage kidney disease (ESRD and ESKD). These are the most advanced stages of kidney impairment.
Hemodialysis is the removal of toxins, fluid and salt from the patient’s blood through a machine called a dialyzer.
The treatment usually occurs in an outpatient dialysis center, but it can also be done at home. Each treatment lasts for about one and a half hours and needs to be performed three times per week.
It’s estimated that more than 30 million people in the US have some type of kidney disease of which 809.000 had ESRD in 2019.
The ideal treatment for someone suffering from ESRD is kidney transplant, but there’s not enough kidneys to go around and the average waiting time for a surgery is 5 years. That’s why the dialysis business exists.
Relevant Financials
Revenue growth for DaVita has slowed in recent years as the industry is mature and the US market has consolidated.
The company has been able to get stable profit margins…
… and has been able to convert those profits into even higher cash flows.
So, what should a mature, cash generating business, do with its cash flows when it doesn’t have significant opportunities to redeploy that cash into growth?
Give it back to the shareholders – through share buybacks or dividends. Fortunately for DaVita’s shareholders, the management has been buying back enormous amounts of shares.
That’s why DaVita is nicknamed a cannibal: because it “eats” its own stock. In the past 5 years alone the share count has been reduced by 50%.
This has led the Earnings-per-Share to skyrocket.
And all of this while just gently raising its leverage.
Some investors get a bit worried that a 3.7x Net Debt/EBITDA ratio might be too high, but you need to remember that this is as steady of a business as they come. When patients begin hemodialysis treatment, they never go back. It’s better than a subscription model. Such stable businesses can handle high amounts of debt.
In some ways, DaVita reminds me of AutoZone which for the past I-don’t-know-how-many-years has been buying back its own shares and delivering stupendous returns to its shareholders. The main difference between the two, I would say, is that Davita can’t grow market share while AutoZone still can.
And there’s yet another huge difference to AutoZone. The Return on Invested Capital for DaVita has been going down dramatically. This is an obvious yellow flag that I’ll be digging into.
Management and Ownership
As mentioned above, Berkshire Hathaway is the largest shareholder with 38% of the shares outstanding. The remaining largest shareholders are institutions.
Javier Rodriguez stepped up as CEO in 2019, when he replaced Kent Thiry who had been in the job for 20 years.
Javier earned $18 million in compensation in 2020 of which $17 million were performance awards.
There are two types of awards: the short term incentive program and the long term incentive program.
The short term incentives are tied to the Operating Income (50%), the Free Cash Flow (20%) and to operational goals (30%).
The long term incentives are tied to Earnings-per-Share (75%) and share price performance relative to a benchmark (25%).
I’m OK with these metrics although I would like to see Return on Invested Capital present among them.
Conclusion
I’ve purposely made this write-up short because the investment thesis is also quite simple: DaVita is a stable business, part of a duopoly, generating lots of cash flow that it uses to buy back its shares at an attractive valuation (8x Free Cash Flow or a FCF Yield of 12.5%).
But then come the questions: How does the company make money? It seems like an easy answer, right? Not really. Because it leads to other questions: Who pays for the dialysis? Well it is paid mostly by the national health insurance program Medicare and, to a lesser extent, by commercial insurers. But that leads to other questions: How likely is that the Medicare reimbursement rates will remain as they are and what are the chances of them changing?
This, in turn, leads to a deep research of how these reimbursement mechanisms work, how the healthcare in the US is changing, how lobbying is allowing DaVita and Fresenius to keep their duopoly, and to a lot of other questions that I need to answer before I can consider buying DaVita (or Fresenius).
Next week I’ll be diving into these subjects and I’ll also be looking into Fresenius.
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