DVA DaVita Inc

We have upgraded our recommendation on DaVita Inc. (DVA) to Outperform from Neutral based on the company’s strong cash flows and strategic acquisitions. The bundled ESRD payment system is also expected to be a long-term positive.

DaVita reported third-quarter 2011 operating earnings of $138.2 million or $1.45 per share, exceeding the Zacks Consensus Estimate by a penny. Results were also higher than the $119.5 million or $1.15 per share earned in the comparable quarter of 2010.

DaVita has been generating strong operating cash flow accruing from improved earnings and robust cash collections, leading to a 4-year CAGR (2007–2010) of 13.1%. Higher-than-expected cash flow during the first three quarters of 2011 also allowed the company to raise its 2011 operating cash flow guidance to $1.02–1.10 billion from $900–980 million. The company projects similar growth in the future and believes that it will be able to meet its capital expenditures, as well as repurchase shares and spend on acquisitions.

In addition to improving its operating performance, DaVita constantly seeks to generate cost efficiencies. The recent long-term Epogen purchase deal with Amgen Inc. (AMGN) is expected to significantly reduce the company’s expenditure on Epogen, a medicine used for increasing red blood cells in kidney patients.

Moreover, DaVita is regularly expanding via acquisitions. In January 2012, the company’s subsidiary – Paladina Health LLC – announced the acquisition of ModernMed, which operates clinics and physician practices in 12 states across the U.S.

However, DaVita is facing multiple investigations for over-billing of Medicare and over-use of Epogen. If the charges are found to be true, the company will not only suffer substantial reduction in goodwill, but will also face several lawsuits and might be heavily fined, weighing on the financials.

Moreover, a significant portion of DaVita’s dialysis and related lab services revenues are generated from patients who have commercial payors as the primary payor. However, unemployment may result in the shifting of people from commercial insurance schemes to more affordable government schemes.

Moreover, the shift will be harmful as the Medicaid was reduced by many states in 2011 and many others are considering the possibility of reducing the rate. Furthermore, almost 87% of DaVita’s patients already use Medicare or Medicaid programs, thereby leading to additional pressure on the company, as inadequacy of government reimbursements will substantially affect profitability.

The Zacks Consensus Estimate for DaVita’s fourth-quarter earnings is currently $1.48 per share, up about 31% year over year. None of the 12 firms covering the stock revised their estimates in the last 30 days. For 2011, earnings are expected to be about $5.05 per share, climbing about 15% year over year.

DaVita currently caries a Zacks #1 Rank, implying a short-term ‘Strong Buy’ rating.

 
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