DaVita Stock: Its Wide Moat Is Undervalued (NYSE: DVA)

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DaVita Inc. (DVA) is one of the largest providers of kidney care services in the United States, with 37% market share in the dialysis market. According to the company’s 2020 annual report, it provides kidney dialysis services to 204,200 patients through a network of 2,816 dialysis centers. The company also services 3,200 patients through 321 outpatient dialysis centers in 10 other countries. DaVita has a simple business model, providing essential services that are impervious to business and market cycles. It operates in an oligopolistic market, allowing it to defend its profitability. Yet, the company finds itself dramatically undervalued compared to the market.

Dialysis is Essential for ESRD Patients

DaVita’s patients are largely suffering from end-stage renal disease or end-stage kidney disease (ESRD or ESKD), which is an advanced stage of kidney impairment that requires continued dialysis treatments or a kidney transplant to sustain life.

Dialysis is used to remove toxins, fluids and salt from patient blood. Patients with ESRD typically require dialysis three times a week for the rest of their lives.

The ideal treatment for ESRD is to receive a kidney donor, however, the odds of getting one are very low. According to HRSA organdonor.gov, there are nearly 107,000 patients on at least one of the 57 waiting lists held by Organ Procurement Organizations across the country, with just 39,000 kidney transplants performed in 2020. The American Kidney Fund estimates that the average wait time for a person who gets a kidney donor is 5 years. This is due to a lack of kidneys, says Kidney Donor Conversations, who point out that although many people do offer their kidneys for donation, just 1% of these people will be able to be organ donors.

According to Reuters, a patient is more likely to be added to a waiting list if they have a previous heart, lung or liver transplant. The typical patient who gets a kidney transplant has already been on dialysis, although a third with prior organ transplants preventively got on a waiting list before getting dialysis in order to improve their survival chances. Preventive listing only happens with 20% of patients who have had no prior organ listing.

Data from the United States Renal Data System (USRDS) shows that in 2019, 61.1% of patients with ESRD had in-center hemodialysis, down from 63.9% in 2009; while patients received 7.7% of patients received peritoneal treatment, up from 5.3% in 2009 to 7.7%. In the last decade, patients who receive a functioning kidney transplant are typically around 30% of the prevalent ESRD population. Thus, dialysis is largely unavoidable for patients suffering from ESRD.

2021 United States Renal Data System Annual Data Report

2021 United States Renal Data System Annual Data Report

The Dialysis Business

The USRDS ‘last review, showed that, as of December 31, 2019, there were 782,818 prevalent cases of ESRD in the United States, an increase of 40.4% from 2009. Having adjusted for age, sex and race / ethnicity, the USRD found that prevalence was at an all-time high of 2252 pmp in 2019, an increase of 1.3% from 2018.

Prevalence of ESRD

Source: USRDS

There are two options for dialysis treatment: hemodialysis or peritoneal.

Hemodialysis is the most common form of ESRD treatment and is typically performed at a freestanding outpatient dialysis center, the patient’s home, or a hospital-based outpatient center.

Peritoneal dialysis is usually performed at the patient’s home. It is done either through continuous ambulatory peritoneal dialysis (CAPD) or continuous cycling peritoneal dialysis (CCPD). It does not require thrice-weekly visits to an outpatient dialysis center, and is more suited for healthier patients who want to maintain some semblance of independence and flexibility in their lives.

The federal government provides health coverage for ESRD patients, regardless of age or financial circumstances, under its Medicare ESRD program. The Kidney Project estimates that although those with ESRD make up just 1% of the Medicare population, they take up about 7% of the Medicare budget.

Normally, Medicare becomes the primary payor for a patient without a commercial insurance plan either immediately or after a three-month waiting period. However, for patients with commercial insurance coverage, Medicare becomes the primary payor after 33 months, including the three-month waiting period, or earlier if the patient’s commercial insurance coverage ends. Where Medicare is the primary payor, DaVita is paid according to Medicare’s payment rates, which are usually significantly lower than commercial insurance rates. DaVita claims to lose 10-15% on Medicare patients, although these figures have been contested.

DaVita is a price-taker when it comes to Medicare, and has to accept its low rates. Payments generated from commercial insurance plans make up nearly all of the company’s profits, and all its non-hospital dialysis profits come from commercial payors, even though patients with commercial insurance plans make up just 10% of its patient population. Payments are made either in a lump-sum payment, known as “bundled rates”, or separate payments for dialysis treatments and pharmaceuticals, known as FFS rates.

Patients covered by Medicare serve an important purpose: they give the company economies of scale (delivering 60-60% of revenues), which it can then leverage to negotiate significantly higher rates from commercial insurers or third-party administrators of up to four times as high as Medicare rates. This is due to the duopolistic nature of the dialysis market.

The Dialysis Duopoly is Driving Rising Profitability

DaVita and the German-owned firm Fresenius, dominate the dialysis industry, with 70% market share. The two giants have been able to consolidate the industry around them, buying up dialysis clinics across the country and dictating prices of inputs such as medical devices, and taking over manufacturers of dialysis machines.

This duopoly allows these two firms to keep commercial rates high, and defend their profitability. They are able to tie commercial insurers to five-year contracts, which gives them a degree of predictability in terms of revenues as the company’s revenues numbers testify: revenues in 2018 were $ 11.4 billion, compared to $ 11.55 billion in 2020 and $ 11.58 billion for the trailing twelve months (TTM) period.

The scale comes from the efficiencies that come with it, and DaVita is able to provide its care services at a low cost. Scale also means that DaVita is, along with Fresenius, one of the top names that come up when doctors are referring their patients for dialysis services.

According to the company’s Q3 2021 report, average patient service revenue per treatment was $ 358.42 for the first nine months of 2021, compared to $ 349.82, which is much lower than acute care hospitals, which means that Medicare and commercial insurers have strong incentives to have patients go to DaVita as opposed to other options.

This competitive landscape makes it hard for DaVita not to be profitable and makes it even harder for entrants to challenge its position. The company earned net income of over $ 616 million in 2018, rising to more than $ 783 million in 2020, and standing at $ 984 million in the TTM period, despite miniscule revenue growth (hit by higher mortality due to Covid-19). In Q3 2021, the company made nearly $ 320 million in net income, up from over $ 217 million in the same period in 2020. In the first nine months of 2021, the company earned more than $ 962 million, compared to more than $ 760 million in the same period in 2020.

The company has grown free cash flow (FCF) from more than $ 784 million in 2018, to over $ 1.3 billion in 2020, and just over $ 1.2 billion in the TTM period. In the first nine months of 2021, the company earned $ 843 million in FCF, compared to $ 977 million in the same period in 2020.

With an enterprise value of $ 22.17 billion, DaVita has an FCF yield of 5.5%, which is a very attractive rate and shows that the market has undervalued the company’s growing FCF. Furthermore, the company has a forward P / E multiple of 13.53, compared to the S&P 500 P / E multiple of 26.16.

This also tells us that the company can support its aggressive share repurchase programs. In 2018, the company bought nearly $ 1.2 billion of its own shares, which rose to nearly $ 2.4 billion in 2019, and almost $ 1.5 billion in 2020. In the first nine months of 2021, the company spent $ 882 million on share repurchases, compared to over $ 1 billion in the same period in 2020.


DaVita’s growth prospects are small, given its size. However, the company’s scale allows it to command attractive rates that will ensure that its profitability continues to grow. Moderate growth can be funded while maintaining a high level of share repurchases. The company’s simple, robust, stable and profitable business is available at a low valuation.

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