We are downgrading our recommendation on
) to Neutral based on an unfavorable shift in payor mix, headwinds
from debt refinancing and ongoing concerns related tothe health
care reform. However, the company's strong cash flow and steady
inorganic growth together limit the downside.
DaVita reported fourth-quarter operating earnings of $1.58 per
share, which topped the Zacks Consensus Estimate of $1.48 and $1.13
in the prior-year quarter. Operating income amounted to $149.4
million, compared with $111.9 million in the fourth quarter of
DaVita has been generating strong operating cash flow, which
increased at a 3-year CAGR (2008-2011) of 24%. The strong cash
flows allow the company to meet its capital expenditure needs as
well as repurchase shares and spend on acquisitions, which has been
DaVita's preferred business strategy over the years.
During 2011, the company increased its tally of outpatient
dialysis centers by 208, which can be credited to acquisitions and
opening of new centers. Apart from domestic acquisitions, the
company is also looking for acquisition opportunities in all major
European and Asian countries.
While DaVita's Epogen purchase deal with
) has marginally increased the cost of Epogen in the near term, it
is expected to significantly reduce the company's future
expenditure on the drug. It is likely that the company received
substantial discounts and rebates under the agreement, which
prompted it to sign a seven-year deal despite the fact that
Epogen's patent is set to expire in 2014 and low-cost competing
products will be available in the market.
On the flip side, 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, the mix of
treatments reimbursed by non-government payors, as a percentage of
total treatments, has been falling consistently over the years due
to the wide disparity in the payment rates of commercial insurance
and government schemes.
Moreover, the impact of the health care reform could adversely
affect DaVita's earnings. One provision requires the establishment
of health insurance exchanges, which is expected to reduce the
number of policyholders opting for commercial insurance.
Moreover, even those policyholders who choose to stay with
commercial insurance are likely to opt for policies with limited
benefits, carrying lower reimbursement rates. Consequently, the
earnings of DaVita could be adversely affected by the establishment
of the exchanges.
The Zacks Consensus Estimate for DaVita's first-quarter earnings
is currently pegged at $1.45 per share, up about 51% year over
year. For 2012, earnings are expected to be about $6.24 per share,
climbing about 21% year over year.
DaVita currently caries a Zacks #3 Rank, implying a short-term
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