DaVita’s (DVA) narrow economic moat is due to the company’s dominant and essential position in the U.S. dialysis market, accounting for over one third of all dialysis facilities and patient treatments. While there’s been much investor concern over the last few years that ultimately stems from an industry structure that levies industrywide profits on a small handful of commercially insured patients, we’d caution investors to not lose sight of the bigger picture. DaVita provides lifesaving healthcare services to chronically ill patients in a low-cost, outpatient setting. Because the alternative to outpatient dialysis is higher-cost, less-efficient, and more-burdensome acute therapy, we see little likelihood of DaVita faltering due to regulatory disruption in the long term. We think continued scrutiny of patient assistance programs could cause near-term pain for the industry, limiting patients’ ability to continue on their commercial plans. Over time, however, we think this would catalyze further industry consolidation, leaving DaVita in a comparably advantaged position versus smaller, independent peers that lack the cost advantages present in its operations. We think investors need to balance these risks against the industry’s compelling volume growth that is likely to average in the low to mid-single digits annually.
We take a favorable view of management’s recent sale of the DaVita Medical Group assets. Long a drag on profitability and returns on capital, the business had perennially underperformed following its acquisition in 2012. Absent any major structural changes to dialysis reimbursement policy, we anticipate DaVita’s returns on capital to improve as management focuses on scaling up its international presence without the distraction of DMG. While our assessment is that management’s capital-allocation prowess is somewhat tarnished by its experience with DMG, its planned use for the $4.9 billion in proceeds is largely debt reduction and stepped-up share repurchases, which we like as near immediate value-creating capital-deployment options.
Jake Strole, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.