DaVita Inc.’s (DVA) fourth quarter earnings exceeded by a penny compared to the Zacks Consensus Estimate on modest top-line growth, partially offset by higher operating expenses. We have thus reiterated a Neutral rating on DaVita.
Revenue in the quarter climbed 5.2% year over year to $1.65 billion, while it increased 5.6% year over year to $6.45 billion in fiscal 2010. However, they were offset by the rise in total operating expenses and charges, which climbed 4.9% year over year to $1.39 billion in the quarter.
Growth also emanated from the expected free cash flows of DaVita from improved earnings, robust cash collections and the timing of payments for working capital expenditures, which have been increasing at a 4-year CAGR (2007-2010) of 13.1%.
However, DaVita’s debt refinancing continues to keep its financial leverage at elevated levels. Though DaVita’s cash flows remain strong, it has to depend upon future borrowings to service its debt and fund other liquidity needs. In addition, increases in interest rates may increase DaVita’s interest expense and adversely affect the earnings and cash flow and the ability to service its debt.
Further, DaVita has been acquiring dialysis centers and businesses that own and operate dialysis centers, as well as other ancillary services and strategic initiatives since years. In 2010, the company added a net total of 82 outpatient dialysis centers, representing a total increase of approximately 5% to the overall network of outpatient dialysis centers.
Besides these centers, DaVita agreed to acquire its competitor DSI Renal, Inc. (DSI), for approximately $690 million, which is expected to complete the deal by the second or the third quarter of 2011.
Furthermore, DaVita started a new bundled ESRD payment system on January 1, 2011 under which Centers for Medicare and Medicaid Services (CMS) will reimburse dialysis facilities with a single payment for all items and services provided.
This rate encompasses services included in the composite rate, all ESAs such as Epogen (EPO) and other pharmaceuticals (other than vaccines) furnished to the patients that were previously reimbursed separately, and all diagnostic laboratory tests. In addition, CMS has proposed to include Part D drugs related to the provision of dialysis in the bundled rate as well.
Although the new reimbursement system will take time to adjust operations and might pose a headwind to 2011 earnings, it is expected to be a long-term positive, while also profiting from the adjustment in cost structure of the Medicare business. Currently, we expect uncertainties in the payment structure under the bundled payment system and the impact of health care reform legislation on the company.
The quantitative Zacks #3 Rank (short-term Hold rating) on the stock indicates no directional pressure on the shares over the near term.
Headquartered in Denver, Colorado, DaVita is a leading provider of dialysis services in the U.S. to patients suffering from chronic kidney failure, also known as end-stage renal disease (ESRD). The company competes with Fresenius Medical Care AG & Co. KGAA (FMS).
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