A Cheap, Promising Healthcare Opportunity

Jake Strole: We think both DaVita and Fresenius Medical Care are well positioned within the dialysis services industry. The cost advantages associated with substantial scale ensure that these businesses consistently earn respectable returns on capital and help define their narrow economic moats. Further, while these firms are best positioned among peers providing dialysis treatments in the clinic, we also think they are poised to benefit as more patients look to receive treatments at home.

While home therapy is the primary treatment method for just over 10% of patients today, better provider economics, patient preference, and lower all-in cost requirements suggest the market will likely trend toward higher utilization of home-based treatment modalities over time. We think the penetration rate of home therapy could ultimately reach 25% of patients, representing a sizable market shift that creates opportunities and risks for dialysis providers such as DaVita and Fresenius.

While we believe cost advantages exist to protect the moatworthy in-center businesses of both of these firms, intangible assets, such as each company's relationship with practicing nephrologists, will help protect economic returns in the home setting. Additionally, these firm's established clinic networks create an asset that other companies will find hard to replicate, acting as a gateway through which competing products must travel in order to drive adoption. Fresenius' recent acquisition of home hemodialysis leader NxStage Medical highlights this dynamic well. Given similar reimbursement but lower all-in costs than in-center treatment options, home therapy carries a higher margin profile with lower capital requirements for providers, suggesting the return profile of these businesses should improve as more patients benefit from home therapy.

Our outlook for both DaVita and Fresenius remains positive, but after strong stock performance year-to-date for Fresenius, DaVita shares represent a much more compelling investment opportunity from our perspective. At today's prices, the stock trades in 5-star territory and at a nearly 30% discount to our $79 per share estimate of intrinsic value.